Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
Canadian investors are getting a taste of something we’re not very used to these days – a strengthening Canadian dollar. This has taken off some of the luster from the strong performance of many global equity markets in 2017 (an appreciating dollar reduces the returns of foreign holdings). If we take a step back, however, we note that not much has changed.
Generally, expectations of growth in the economy and company earnings are already priced in to today’s stock prices and our managers are finding few attractively priced opportunities.
Bonds, the primary alternative to stocks, offer little upside, despite yields inching higher since November 2016. Thus, our cash position in the Founders Fund has increased. We’re not inclined to buy highly-priced securities just because there’s nothing else to buy.
On an absolute basis, the risk versus return trade-off in bonds remains unattractive. Real yields (the yield after accounting for inflation) on government bonds have risen recently, but are still around zero.
Yields may remain at low levels, or fall again, but as long-term investors we're looking further out and assessing the likelihood that they will normalize over time (when bond yields go up, prices come down). Over the next five years, we expect bonds to return between 1-3% per year, which translates to a 5-15% cumulative return. With those returns is likely to come 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 19% in cash – 14% 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 2016 by adding to a number of positions; however, the breadth of opportunities has since narrowed as markets have climbed higher. (Note: Canadian investors haven't fully benefited from this lift in the last two months because the Canadian dollar has strengthened (an appreciating dollar reduces the returns of foreign holdings).
Our best estimate for 5-year stock market returns is 4-6% per year (20-35% cumulative). For context, our estimate was 7-9% (40-55% cumulative) in early 2016 after stock markets experienced sharp declines.
We recommend investors use contributions and withdrawals to rebalance to their target equity mix. Stocks have been reduced to 56% in the Founders Fund, slightly below the fund’s long-term target of 60%.
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: October 17, 2017