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Building an All-ETF Subset From the Model Fund Portfolio

by James B. Cloonan

Building An All ETF Subset From The Model Fund Portfolio Splash image

Over the past three months the stock market has continued its upward climb despite the dangers on the horizon.

The Model Fund Portfolio is up 17.4% year-to-date but lags the S&P 500 index as measured by Vanguard 500 Index fund (VFINX), which is up 19.7%. As we mentioned previously, the lower return is largely due to our two holdings that provide diversification—Fidelity Capital & Income fund (FAGIX) and Vanguard REIT Index ETF (VNQ).

Figure 1 and Table 2 show performance figures over the long term for the portfolio, the index comparison and the Conservative Portfolio, which is 75% Model Fund Portfolio and 25% iShares Barclays 1-3 Year Treasury ETF (SHY).

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James B. Cloonan is founder and chairman of AAII.


Discussion

William Willes from Louisiana posted 5 months ago:

As a professional investment adviser I have recently structured an all ETF portfolio that I will be using for clients. I feel that ETF's offer many advantages over conventional funds. Several worth considering are inter-day liquidity, lower management fees and the ability to enter stops. Although I appreciate your methodology I feel that it is so conservative that you will be hard pressed to beat the indexes. Unless you are willing to step up and buy some alternative ETF strategies just buy SPY or QQQ.


Joseph Stoutenburgh from Minnesota posted 5 months ago:

I manage my 84 year old mother's trust for income and principal security. Generally I prefer ETFs for broad stock and bond holdings due to their diversification and low cost. However, I have found that when one tries acquire alternative asses classes such as REITS, MLPs and private equity, individual security selection works best.

For example, Mom owns preferred shares of hospital, industrial and hotel REITS purchased at a discount to par, only from firms that have just raised the common share dividend.

MLP funds and ETFs are very high cost products. This is an area where owning 2 or 3 MLPs (e.g. MMP, EPD) with geographically diversified high quality assets and increasing payouts is better than holding a basket of 30-40 MLPs, many of which are sensitive to commodity prices.

Likewise, ETFs devoted to private equity are very expensive and you're better off owning 1 or 2 carefully business development companies (e.g. BKCC, KKR).

I like the author’s your pick of Fidelity Capital & Income (FAGIX) for investing in turn-around situations.


James Grant from Ohio posted 5 months ago:

I have 2 issues / questions I hope Mr. Cloonan will address.

Issue/Question #1 - As I read the selection criteria for the ETF-only portfolio, it says the second methodology selects approaches that "have provided excess returns or reduced risk." I am troubled by the word "or". I believe that, unless you are planning to trade the securities in the portfolio, that one cannot achieve both excess returns and reduce risk. Unless you claim otherwise, please offer a list of ETFs for a portfolio that maximizes returns and another set of ETFs that minimizes risk.


Issue/Question #2 - In addition to a "selection methodology", I would like to see some statements about the planned "trading" strategy for the portfolio. In other words, under what circumstances would you reduce holdings in one of the ETFs or drop it entirely? Even if this is intended to be a "long term buy and hold" portfolio, I think it would be appropriate to state for all readers.

Thank you for addressing these matters.


James Grant from Ohio posted 5 months ago:

I guess I will pose a 3rd issue to Mr. Cloonan.

As each of the 3 Guggenheim funds covers a large portion of the stock market, I believe they are very highly correlated. One of the tenets of asset allocation to achieve diversification is to build a portfolio of uncorrelated securities. (Sheldon Jacobs made this point in his article "How to Achieve the Right Asset Allocation" which was published in the AAII Journal in June 2012 and redistributed by AAII by email in the last couple of days.)

So, Mr. Cloonan, how do you justify having such highly correlated ETFs in the portfolio? Or do you believe they are uncorrelated?


John Hawkins from Maryland posted 5 months ago:

I'm relatively new to AAII and appreciate the information that is presented to it's readers. The comments also add to the subject content and I look forward to fine tuning my investment strategies. The ETF portfolio is something I'm very interested in !


Lee Dunn from North Carolina posted 5 months ago:


This is a conservative portfolio. Why not add a few excellent ETFs with higher returns? For example:
BBH (Biotech)
CSD (SpinOff)
PNQI (Internet)
ITA (Aero&Defense)

There are many others highly rated by Morningstar with much higher annual returns.


Robert Mclaughlin from Virginia posted 5 months ago:

I appreciate the information on an all ETF portfolio. It certainly makes rebalancing a lot easier and I believe it is diversified enough to provide acceptable risk. My brokerage account is with Fidelity and many of the IShares ETFs trade for free. For example I use ITOT, IJH and IJR for large, mid and small cap ETFs. I don't use Frontier ETFs (maybe I should) but use IEFA and IEMG in a ratio of 2 to 1 for international and Emerging markets respectively and then IYR for Real Estate. All trade free and the comparable ones to the model ETF portfolio are better YTD.


Garrett Cowsert from Arizona posted 5 months ago:

I agree with J Grant. Similarly, it looks like you could just about replace the first 4 etfs with something like VTI as together they seem to cover the whole market. I'd like to see a comparison of what would happen


Robert O'Neill from Massachusetts posted 5 months ago:

These comments are very refreshing and indicative of a caring, thoughtful, yet sophisticated investor base that is a tribute to AAII and its community. No hype, no hysterical comments - nice going folks


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