Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
All our funds have remained cautiously positioned through the recent volatility in bond and global stock prices. The managers of our equity funds have found few new opportunities through the tumult as valuations remain above historical averages. Our Income Fund manager also remains watchful, reducing exposure to corporate bonds last year in favour of provincial bonds for their defensive qualities. All our managers, however, have done their homework and are ready to act as opportunities arise.
In the Founders Fund, we hold less stocks than our long-term target and have added to bonds and cash over the last year. Bonds, however, continue to be below their long-term target given their limited upside potential.
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. These returns are likely to come 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 2016 by adding to positions; however, the breadth of opportunities has since narrowed as markets have climbed higher. Despite the most recent fall in stock prices, valuations remain at elevated levels.
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 long-term asset mix, making sure equities are at or slightly below target. In the Founders Fund, stocks have been reduced to 54%, which is 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: May 3, 2018