Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
The hot start to the year hasn’t carried through the rest of 2019. And recently, equity markets have fluctuated more as they respond to the lack of clarity on trade, politics and global growth. What is clear, however, is that the global economy is showing signs of slowing and policymakers around the world are attempting to address the situation.
While some caution is warranted, it’s important to not get carried away. At any point in time, stock prices reflect investors’ view of future growth. Which means a lot of the negative sentiment is being factored into stocks today. Moreover, our equity funds look very different from the market. Our managers have stayed away from the hyped areas in favour of those stocks that are currently being overlooked. This has impacted recent performance, but we trust the moves will bear fruit over the long term.
In the Founders Fund, we maintain our slightly below-target allocation to stocks – 59% vs. 60%. Our bond holdings remain below target (28% vs 35%) but have been increased to reflect changes in our Income Fund. The manager of the fund, Connor, Clark & Lunn, has allocated more to government bonds than bonds of corporations. The former are a better diversifier for stocks and have defensive properties in times of economic malaise.
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.
Despite our lowered return outlook, bonds remain an important tool for most clients. They provide ballast when stocks are volatile (as was the case in the fourth quarter of 2018), and as such, are a diversifier for a balanced portfolio. The Founders Fund currently holds 28% in bonds and 13% in cash — 8% 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: October 10, 2019