Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
2016 is a good portrayal of our usual advice to clients. When the sentiment was negative in the early part of the year, and stock prices were falling, we suggested investors take advantage of the broad sell-off. In the Founders Fund we quickly raised the equity weight to 68%.
As fear subsided, and stocks rallied, we started trimming the Founders Fund’s equity holdings back toward its long-term target (60%) and advised clients to do the same.
That rally has kept going and stocks are, once again, getting expensive. Our equity managers are finding few attractively priced opportunities. Bonds, the primary alternative to stocks, also provide little upside, despite yields recently inching higher. Thus, we have been adding to our cash position. While it provides little in the way of returns, it acts as a safety net when prices of stocks or bonds fall.
On an absolute basis, the risk/return trade-off in bonds remains unattractive. Real yields (the yield after accounting for inflation) on government bonds have recently risen, but are still around zero.
Yields may remain at low levels, or fall again, but as long-term investors we are concerned about them increasing over the next 1-5 years (when bond yields go up, prices come down). Over the next five years, we expect bonds to return between 1-3% per year, with higher volatility than investors have been accustomed to.
We recommend keeping bond holdings below your long-term target and setting aside a cash reserve. Cash provides protection against rising interest rates, acts as a safety net in the face of challenging economic times and provides liquidity when markets are down. The Founders Fund currently holds 17% in cash – 12% more than its long-term target.
When considering how much to invest in stocks, we focus on the opportunities our managers see and the attractiveness of stocks in general. Our managers took advantage of lower stock prices early in the year by adding to a number of positions; however, the breadth of opportunities has since narrowed as markets have climbed to all-time highs.
Our best estimate for 5-year stock market returns is 4-6% per year. For context, our estimate was 7-9% in early 2016 as some markets faced sharp declines.
We recommend investors use contributions and withdrawals to rebalance to their target equity mix. Stocks have been reduced to 60% in the Founders Fund and will be further pared back if markets continue their upward trajectory.
If you would like an assessment of your portfolio or a second opinion, give us a call (1-888-888-3147). We provide advice and can help better align your investments to your personal situation.
Founders Fund Asset Mix: January 4, 2017