Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
The coronavirus (COVID-19) is a good reminder that risks can appear unexpectedly. The wild day-to-day swings also tell us that investors are not yet able to differentiate between companies that might come out strengthened and those that will be weakened.
Our managers have been responding to the volatility by adding to existing positions and making new purchases. They’ve also trimmed or sold stocks when the outlook has changed significantly. In the Founders Fund, we’ve raised the equity weight to 64% from 57% in late-February. We started gradually and increased the pace of purchases on days when the markets experienced their steepest declines. Though we don’t know if stock prices rise from here or fall further, our shift reflects the fact that our managers are able to buy great long-term businesses that were previously out of reach.
The outlook for bonds depends on where you look. Government bonds have provided the defense we expect, but their future return potential has diminished. By contrast provincial and corporate bond spreads (the extra yield over a similar Government of Canada bond) have widened and their return prospects have improved for investors who understand the bonds may continue to trade erratically in this period of uncertainty.
Though the overall yield of a portfolio of bonds has risen, on an absolute basis, the risk versus return trade-off remains unattractive. The yield increase is driven by investors demanding higher yield to hold any bonds not issued by the federal government. The yield increase also comes despite federal bond yields falling (and bond prices rising) as investors flock to safety. Real yields on governments bonds (the yield after accounting for inflation) are now negative.
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.
Our fixed income manager is still positioning the Income Fund defensively but has started adding more to provincial and corporate bonds. In the Founders Fund, we’ve maintained our below-target weight in bonds. Instead, we’re holding cash which also provides some defence while giving the fund liquidity, something the market doesn’t have enough of.
Despite our lowered return outlook, bonds remain an important tool for most clients. They provide safety when stocks are volatile (as they have been recently), and as such, are a diversifier for a balanced portfolio. The Founders Fund currently holds 26% in bonds and 10% 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 managers are seeing more opportunities and stocks are more reasonably priced than they were at the start of the year, in general. Our best estimate for 5-year stock market returns has increased to 6-8% per year (30-45% cumulative). For context, our estimate was 5-7% before the recent sharp price declines.
We recommend investors keep their stock allocation in line with or slightly above their long-term target. The Founders Fund currently holds 64% of its assets in Canadian and global stocks compared to its 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: April 6, 2020