Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
The continued the lack of clarity on trade, politics and global growth means risks remain and some caution is warranted. But it’s important to not get carried away. Our equity funds look very different from the market and our managers have stayed away from the hyped areas in favour of those stocks that are currently being overlooked. This means our funds, which experienced strong absolute returns, haven't kept up with the red hot markets. We trust our positioning will bear fruit over time.
In the Founders Fund, we maintain our target allocation to stocks. Our bond holdings remain below target (27% 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 corporate bonds. The former are a better diversifier for stocks and have defensive properties in times of market unrest.
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 27% in bonds and 13% in cash.
When considering how much to invest in stocks, we're guided by 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, our estimate was 6-8% after the price declines in the fourth quarter of 2018. Since then stock prices have risen sharply. Additionally, company profits have consistently grown over the last eight 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 60% 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: January 8, 2020