Our model portfolio of exchange-traded fundshas now been in existence for four years—four pretty dramatic years. That it has averaged less than 1% a year return would certainly be a disappointment were it not for the fact that most all of the market as well as the benchmarks have negative returns for the four years.
While the Model ETF Portfolio rebounded very well in both of the last two quarters, it has not reached its pre-2008 highs, as can be seen in Figure 1.
Year-to-date the ETF portfolio is up 8.9% compared to 4.7% for our ETF benchmark.
A major difference between the model portfolio and its benchmark is that our Model ETF Portfolio has a 21% real estate component and the benchmark does not. This hurt relative performance when real estate was hit even harder than the overall market in 2008, but is helping now that real estate has begun to recover. I should point out again that the real estate investments in our two ETFs are mostly real estate investment trustsin diversified commercial real estate holdings and not houses.
Another point of interest is the recent relative weakness in foreign stocks—even the emerging markets. While some individual countries continue to outperform, overall foreign stocks are performing less well and the correlation with U.S. stocks is increasing so the diversification advantage, while it still exists, is not as strong as two years ago. All of the returns can be reviewed in Table 1.
We are not making any changes in the portfolio. We continue to wish there was a more value-oriented micro-cap ETF, but it is unlikely to happen because of a lack of interest. Over the intermediate term, the real estate portfolios are still lagging a bit, probably due to worries about some portions of the commercial real estate market. We continue to believe that real estate is an important part of a portfolio and will provide returns similar to equities and, at the same time, provide diversification and risk reduction.
Although there was early volatility this year, the stock market seems, as of early April, to be having a fairly normal year. Half the experts say the valuations are too high and the other half say they are too low, which would portend for reasonable growth and stability. But we are all a bit rocky from the last two years and there are a number of unknowns, so it is hard to be too optimistic. I continue to feel that there is no reason to leave one’s normal allocations.
I will be reviewing the Model ETF portfolio again in the November 2010 AAII Journal, but you can follow it at AAII.com in the meantime.
|1 Year||3 Year||4/1/2006|
|First Trust Dow Jones Select MicroCap Index (FDM)||16||7.0||60.6||-7.1||-4.2|
|PowerShares FTSE RAFI US 1000 (PRF)||16||8.8||79.0||-2.5||1.5|
|Rydex S&P MidCap 400 Pure Value (RFV)||16||13.7||130.3||-1.9||2.6|
|Rydex S&P SmallCap 600 Pure Value (RZV)||16||19.0||163.0||-3.1||-0.4|
|iShares Cohen & Steers Realty Majors (ICF)||16||9.9||114.1||-13.7||-5.4|
|SPDR S&P International Small Cap (GWX)*||5||5.0||67.5||na||na|
|SPDR Dow Jones International Real Estate (RWX)*||5||0.9||68.3||-15.9||na|
|Vanguard FTSE All-World Ex-U.S. (VEU)*||5||1.8||61.3||-3.8||na|
|Vanguard Emerging Markets (VWO)||5||2.5||80.4||5.0||35.2|
|iShares Barclays 1-3 Year Treasury Bond (SHY)||0.6||1.2||4.5||1.0|
|iShares D.J. U.S. Index (IYY)||5.7||51.8||-3.8||-2.0|
|iShares MSCI EAFE Index (EFA)||0.7||53.8||-7.1||-3.6|
|ETF Benchmark (80% IYY/20% EFA)||4.7||52.2||-4.4||-2.4|
*Funds have not been in existence long enough for certain performance numbers to be calculated.
**Performance of actual portfolio including reinvested dividends.
Sources: Yahoo! Finance and Morningstar Principia. Data as of 3/31/2010.
Updates for the ETF Portfolio will appear in the May and November issues of the AAII Journal. See the ETF Portfolio area of AAII.com for more information.
The rationale used in building the Model ETF Portfolo is to achieve diversification across the equity classes listed below while maintaining a weighting that, in our assessment of historical data, will provide the maximum opportunity for long-term rates of return. We have a bias toward smaller-cap and value stocks and so does history.
We begin with an 80% U.S. and 20% foreign portfolio but this could change. Foreign stock returns involve currency relationships as well as the usual equity analysis. The initial weighting takes into consideration the fact that many U.S. companies have significant foreign involvement.
Although the above outlines the areas in which we will look for ETFs, it does not explain how we will choose specific ETFs when there are multiple ETFs in an area.
It will be many years before we have enough history to develop a solid set of criteria as we have for the Model Mutual Fund Portfolio. Many of the sponsors of ETFs, however, have a history with other investment vehicles that can provide a guide, as can liquidity, expense ratios, and the philosophy espoused in prospectuses. Over time, we should be able to harden our criteria.
We will not make trades solely for the purpose of rebalancing, except under unusual conditions. When we make trades for other reasons, we will do so in a way that repositions the portfolio back toward the initial weighting.
The current recommended initial weighting is to give each domestic holding an equal weight (for a total of 80% in domestic ETFs) and each foreign issue an equal weight (for a total of 20% in foreign stock ETFs). If you choose not to hold a particular ETF, maintain the equal weightings in each of the domestic and foreign areas, and keep the balance of 80% domestic stock ETFs and 20% foreign stock ETFs.