Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
When assessing the investing climate, we focus on three things: fundamentals, valuations and sentiment. While many of the fundamentals underpinning the global economy are sound, the prices investors are willing to pay for stocks and the broadly positive mood give us pause, even after the most recent equity market decline.
Generally, the expectations of continued growth in the economy and company earnings are already priced into today’s stock prices. As a result, our managers have found new investment opportunities difficult to come by. The degree of speculation is also at high levels. This sentiment may propel stocks higher, but we worry it’s causing investors to ignore the headwinds: record levels of debt, low productivity, and high valuations.
In the Founders Fund, we hold less stocks than our long-term target and added to bonds and cash over the last six months for their defensive qualities. 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%, 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: February 19, 2018