Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
Investors who showed patience in late 2018 have been rewarded by strong returns. Domestic and foreign equity markets have seen double-digit gains in 2019. Stock valuations are once again within their long-term range and pockets of over-exuberance are beginning to re-emerge in speculative areas like unprofitable technology stocks. We believe that balanced portfolios should be in line with, or slightly below their long-term equity targets.
Canadian bond prices have also seen a sharp increase as bond yields have fallen across the board over the last year. Today government bonds yield less than inflation and are nearing their all-time lows. The Founders Fund continues to hold bonds for diversification but has set aside cash as a buffer.
On an absolute basis, the risk versus return trade-off in bonds remains unattractive. Real yields (the yield after accounting for inflation) are around zero and even negative in some cases. In the last six months, bond yields have fallen (and bond prices have risen) as investors worry about the fragility of the world economy.
Yields may remain at low levels, or fall further if the economy falters, but as long-term investors we're looking further out and assessing the likelihood that they will normalize over time. Over the next five years, we expect bonds to return between 1-3% per year, which translates to a 5-15% cumulative return. These returns are likely to come with higher volatility than investors have been accustomed to.
Bonds provide ballast to a portfolio when stocks are volatile (as was the case in the fourth quarter of 2018) and as such, are an important diversifier for a balanced portfolio. Nonetheless, we continue to recommend keeping bond holdings below your long-term target and setting aside a cash reserve. The Founders Fund currently holds 26% in bonds and 15% in cash — 10% 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 best estimate for 5-year stock market returns is 5-7% per year (25-35% cumulative). For context, after the fourth quarter price declines our estimate was 6-8%. Since then stock prices have risen sharply. Additionally, company profits have consistently grown over the last 8 years and we are seeing signs that investors might be overly optimistic about future profits.
We recommend investors keep their stock allocation in line with their long-term target. The Founders Fund currently holds 59% of its assets in Canadian and global stocks.
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: September 5, 2019