Magellan Financial Group Ltd’s (ASX: MFG) CEO Hamish Douglass has sounded a warning and believes there is a possibility global share markets could see a 30% fall in the next 12 to 18 months, according to a letter to shareholders.

Magellan is one of Australia’s largest fund management businesses with around $69.5 billion of funds under management at the end of June 2018, according to an ASX announcement earlier this month. Douglass is the co-founder and lead investor at Magellan.

Magellan’s flagship Global Fund has returned an average of 18.2% each year, after fees, over the past seven years.

Mr Douglass was happy to point out that Magellan has outperformed the MSCI World Index more than 90% of the time, which places it right at the top of global equity managers when comparing consistency of out-performance.

Why the selloff?

Mr Douglass said that if the US 10-year Treasury bond yield goes above 4% during the next year and a half, it could lead to a 30% sell-off of global shares if the US Federal Reserve is surprised by inflation.

“In our view, a 20% to 30% global stock market correction in the next 12 to 18 months is conceivable,” Douglass wrote in his annual shareholder letter.

However, he also said the US Fed could keep raising rates in an orderly fashion and there might not be an inflation scare.

He has positioned his portfolio to be safer, by increasing the cash to the highest level since the GFC.

“While global stocks have set record highs over the past 12 months, we are cautious on the outlook for equity markets and consider that risks are asymmetrical to the downside.”

Douglass is focusing on defensive shares like Lowe’s, Costco and Kraft Heinz as well as platform businesses that profit from network effects like Alphabet (Google), Facebook, Apple and Visa.

However, he reminded investors that investing in share markets is inherently risky.

“In our view, only conservative investors sleep well.”