• AAII Model Portfolios
  • Model Fund Portfolio: Adjust Risk Based on Personal Factors

    by James B. Cloonan

    Model Fund Portfolio: Adjust Risk Based On Personal Factors Splash image

    The stock market continues its upward movement despite anticipation of a pullback.

    The Model Fund Portfolio is up 7.5% and the All-ETF Portfolio is up 7.7% year-to-date. This compares to 7.0% for the S&P 500 index as represented by the Vanguard S&P Index fund (VFINX).

    Results for the Model Fund Portfolio over longer periods can be viewed in Figure 1 and Tables 1 and 2. Performance for the All-ETF Portfolio is shown in Table 3. The Vanguard REIT Index (VNQ) exchange-traded fund continues to lead the pack and is making up for the weak period a year ago. The iShares MSCI Frontier 100 (FM) exchange-traded fund, up 9.9% year-to-date, is still outperforming the Vanguard Emerging Markets Stock Index (VWO) exchange-traded fund, which is up 7.1% year-to-date.

    The All-ETF portfolio continues to outperform the Model Fund Portfolio, but not by a significant amount. It’s about equal to the difference in expenses.

    Small- and mid-cap value stocks continue to lag. They had been the big winners over the past several years, but slowed somewhat earlier this year.

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    Portfolio Changes

    There are no changes to the Model Fund Portfolio.

    Aston/Fairpointe Mid Cap N (CHTTX) and FMI Common Stock (FMIMX) continue to be closed to new investors. Current shareholders should continue to hold these funds, but those investors who do not own them can build a portfolio from the remaining seven funds.

    Presentation Change

    We are no longer running performance figures for the Conservative Portfolio, which we had defined as a portfolio invested 75% in the Model Fund Portfolio and 25% invested in the iShares Barclays 1-3 Treasury Bond (SHY) exchange-traded fund. While I believe that many investors need to be more conservative than being 100% in the Model Fund Portfolio or All-ETF portfolio, I think the appropriate level of risk is unique to each investor. I don’t want the tracking of a sample conservative portfolio to be taken as a suggestion that a particular level of risk is appropriate for many investors, so I have decided it is best to drop calculation of the Conservative Portfolio.

    Type Fund (Ticker) Market
    Cap
    Size
    YTD
    Return
    (%)
    Annual Return (%) Fund
    Assets
    ($ Mil)
    Exp
    Ratio
    (%)
    Std
    Dev
    (36 Mo. Ann'l)
    (%)
    Worst
    3-Yr
    Cal
    Period
    (%)
      1-
    Yr
    5-
    Yr
    10-
    Yr
    Since
    6/30/03
     
    MF
    Aston/Fairpointe Mid Cap N (CHTTX)*
    Large-Cap
    10.3
    30.3
    25.1
    11.4
    13.2
    2,481.5
    1.12
    18.4
    -7.9
    MF
    Fidelity Capital & Income (FAGIX)
    na**
    7.3
    15.0
    15.5
    9.8
    9.8
    10,548.9
    0.73
    8.0
    -7.2
    MF
    Fidelity OTC (FOCPX)
    Large-Cap
    6.8
    34.4
    21.3
    11.1
    nmf
    7,786.2
    0.76
    16.9
    -8.3
    MF
    FMI Common Stock (FMIMX)*
    Mid-Cap
    6.8
    27.5
    19.2
    11.2
    12.3
    1,408.4
    1.19
    12.8
    -3.0
    ETF
    Guggenheim S&P 500 Equal Weight (RSP)
    Large-Cap
    8.4
    26.8
    21.8
    9.5
    11.1
    7,794.1
    0.40
    14.0
    -11.4
    ETF
    Guggenheim S&P MidCap 400 Pure Val (RFV)
    Mid-Cap
    6.5
    25.6
    24.2
    nmf
    nmf
    98.7
    0.38
    16.3
    -4.3
    ETF
    Guggenheim S&P SmallCap 600 Pure Val (RZV)
    Small-Cap
    2.9
    26.7
    21.9
    nmf
    nmf
    178.2
    0.35
    19.5
    -7.9
    ETF
    iShares MSCI Frontier 100 (FM)
    Large-Cap
    9.9
    24.6
    nmf
    nmf
    nmf
    803.3
    0.79
    nmf
    nmf
    ETF
    Vanguard REIT Index (VNQ)***
    Large-Cap
    17.7
    13.4
    23.8
    9.6
    nmf
    23,050.0
    0.10
    16.2
    -11.9
    Avg of Funds in Actual Model Fund Portfolio†
     
    8.5
    25.0
    15.3
    10.4
    11.6
    6,016.6
    0.65
    15.3
    -7.7
    Actual Fund Portfolio Performance††
     
    7.5
    22.9
    14.1
    8.1
    9.8
    12.8
    -6.4
    Optional Investment:
     
     
     
     
     
     
     
     
     
    ETF
    iShares Barclays 1-3 Year Treasury Bond (SHY)
    0.4
    0.6
    1.0
    2.5
    3.1
    7,785.9
    0.15
    0.4
    1.3
    Comparison:
     
     
     
     
     
     
     
     
     
     
    MF
    Vanguard 500 Index (VFINX)
    Giant-Cap
    7.0
    24.4
    18.7
    7.7
    8.6
    28,077.9
    0.17
    12.1
    -8.4

    *CHTTX and FMIMX are closed to new investors. Current shareholders can continue to invest in both funds. Other investors should simply use the other seven funds to form their portfolio.
    **Distressed securities - stock and bond.
    ***Vanguard REIT Index Investors mutual fund (VGSIX) returns used before October 2004.
    †A simple average of the funds in the current Model Fund Portfolio.
    ††Performance of actual portfolio since inception (June 2003) including reinvested dividends.
    nmf = no meaningful figure
    Source: Morningstar, Inc. Data as of 6/30/2014.

    My personal feeling is that investors who are far from retirement—or have another need to withdraw funds—should be almost entirely in equities. On the other hand, for those near retirement (or with another need to withdraw funds) the level of very safe investments should be based on the time that will elapse before the funds need to be withdrawn, not on some percentage of wealth. Since this is unique to each investor, I don’t want to favor a particular level.

      Average Annual Return (%) Cumulative Return of $10,000($)
      Model Fund Portfolio Vanguard 500 Index (VFINX) Model Fund Portfolio Vanguard 500 Index (VFINX)
    2003*
    18.6
    15.0
    11,858
    11,503
    2004
    17.7
    10.8
    13,955
    12,742
    2005
    5.4
    4.8
    14,711
    13,350
    2006
    16.1
    15.6
    17,086
    15,436
    2007
    10.2
    5.4
    18,820
    16,267
    2008
    -35.9
    -37.0
    12,071
    10,245
    2009
    24.9
    26.5
    15,080
    12,959
    2010
    20.3
    14.9
    18,136
    14,892
    2011
    -1.7
    2.0
    17,827
    15,186
    2012
    15.5
    15.8
    20,597
    17,589
    2013
    26.7
    32.2
    26,097
    23,250
    YTD**
    7.5
    7.0
    28,054
    24,885
    Since Inception**
    9.8
    8.6
    26,097
    23,250

    *June 30 to December 31, 2003
    **Through June 30, 2014. Portfolio was started on June 30, 2003.

    We will continue to show the performance of the optional iShares Barclays 1-3 Treasury Bond (SHY) exchange-traded fund investment so that you can calculate the impact it might have on your portfolio given any particular portfolio percentage invested.

    Model Fund Portfolio:
    Selection Rationale

    First Methodology

    The fund selection rationale consists of two distinct approaches. The first approach is to select actively managed funds where the managers have shown a long-term ability to outperform the market after allowing for additional portfolio risk, regardless of the sector invested in. A fund must have the following characteristics to be considered for the Model Fund Portfolio:

    1. It must be a pure no-load fund. Short-term holding penalties are allowed if paid to the fund and not the manager.
    2. It must have been active for 10 years. However, exceptions are possible.
    3. It must have outperformed the S&P 500 index over the past five-year and 10-year periods.
    4. In its worst three-year (calendar) period, it must not have had a loss; or, in particularly difficult market periods, its loss must have been substantially less than that of the S&P 500 index.
    5. Its expense ratio must not be above 1.25%. Lower ratios will increase desirability.
    6. Fund assets must not be over $10 billion. Some exceptions are permitted, depending on fund objectives.
    7. It must currently be open to individual investors, with a minimum investment of $25,000 or less.

    The above rules apply to new fund selections. Funds will not automatically be eliminated if they later violate the rules without considering other factors.

    Second Methodology

    The second methodology selects investment approaches that have provided excess returns or reduced portfolio risk to investors over the long term and then searches for the best traditional fund or exchange-traded fund (ETF) in that area. Factors to be considered are:

    1. The liquidity of the fund.
    2. The resources of the management company, in the case of ETFs.
    3. The investment returns and risk over as long a term as possible, given the newness of so many ETFs.
    4. Selection of areas with demonstrated long-term excess returns: value stocks, small-cap stocks, real estate and special areas where individuals cannot easily invest. An example of a fund in a special area would be Fidelity Capital & Income fund (FAGIX), which invests in distressed securities.

    Portfolio Management Notes

    • The Model Fund Portfolio is meant to be a portfolio, and we suggest you invest in the entire portfolio on an equal investment basis—that is, invest equal dollar amounts in each fund initially. If you are building an All-ETF Portfolio, see the recommended weightings shown in Table 3.
    • If a fund is closed, create your portfolio from the remaining funds.
    • You may make adjustments based on your non-fund holdings. For example, if you have partnership or individual holdings in investment real estate (not personal housing), you may reduce or eliminate any REIT funds.
    • There is no need to rebalance on a regular basis. Rebalancing can be accomplished when there are portfolio changes or if one holding gets way out of line. We will notify you of any rebalancing in the Model Fund Portfolio.

    Outlook

    Over the past two years, more and more pundits have been predicting a major pullback, but the market continues to move up at more than an average rate. I have no idea when there might be a pullback. There are multiple factors that cause concern—from an election and uncertainty about the economy domestically to the most simultaneous conflicts abroad that I can remember. We may see some increase in market volatility, but it would be prudent to maintain your long-term investment posture.

    Fund (Ticker) Weight Annual Return (%)
    YTD 2013
    Guggenheim S&P 500 Equal Weight (RSP)
    40%
    8.4
    35.6
    Guggenheim S&P MidCap 400 Pure Value (RFV)
    20%
    6.5
    38.3
    Guggenheim S&P SmallCap 600 Pure Value (RZV)
    20%
    2.9
    45.1
    iShares MSCI Frontier 100 (FM)
    10%
    9.9
    25.6
    Vanguard REIT Index (VNQ)
    10%
    17.7
    2.4
    Portfolio Weighted Performance
    100%
    7.7
    33.7
    Comparison: SPDR S&P 500 (SPY)
    7.1
    32.2
      Annual Return (%) Cumulative Return
    of $10,000 ($)
      YTD 2013 YTD 2013
    ETF Alternative Portfolio
    7.7
    33.7
    $14,399
    $13,372
    Comparison: Spider S&P 500 (SPY)
    7.1
    32.2
    $14,153
    $13,221

    Source: Morningstar, Inc. Data as of 6/30/2014.

    We will review the Model Fund Portfolio and the All-ETF Portfolio again in the November AAII Journal. In the meantime, you can keep up with the portfolios at AAII.com.

    James B. Cloonan is founder and chairman of AAII. He is author of the forthcoming book "Investing at Level3: Higher Returns With Minimal Risk for the Long-Term Individual Investor".


    Discussion

    George Schmidt from NY posted over 2 years ago:

    In the model fund portfolio why not a lower cost ETF by Vanguard instead of Guggenheim?

    Example: Vanguard Mid Cap Value IVOV has an annual cost of 0.20% vs 0.38% for model fund RFV. Same lower cost for Vanguard IVOV vs RZV. They appear identical and track for the identical performance.


    George Schmidt from NY posted over 2 years ago:

    Correction: Vanguard S&P Small Cap 600 Value symbol is VIOV.


    Conrad Szymanski from FL posted over 2 years ago:

    I have just enrolled in AAII. I am curious as to why the strategy deployed favors mutual funds in the large and mid cap space, and ETF's in the small cap space. My thought has always been that mutual fund houses can add the most value in the small and foreign spaces. I think (but don't know) that the standard deviation analysis of the variation in performance would support my theory. Granted, after 2008, I am drawn to EFT's for their favorable tax consequences; I still believe in the value of first hand research in small and foreign spaces.


    Charles Rotblut from IL posted over 2 years ago:

    Conrad,

    Jim says "The funds were picked for their qualities. Just happened to be large-cap. I agree that managers should be able to add value among smaller cap stocks, but there is no small-cap fund that is currently available that I feel is enough better than the ETF."

    -Charles


    Charles Rotblut from IL posted over 2 years ago:

    George,

    Here's Jim's explanation for using the Guggenheim funds: "Only reason is I prefer to see five years of history. I will probably switch next year if all stays the same."

    -Charles


    Vaidy Bala from AB posted over 2 years ago:

    I like the all out ETF portfolio. From your work it seems reasonable for sustainability.Are ETFs readily cash able, upon need?


    Roy Beamer from NC posted over 2 years ago:

    Since Aston/Fairpointe Mid Cap N (CHTTX) and FMI Common Stock (FMIMX) continue to be closed to new investors, performance of the portfolio should be expressed without them or at least with and without.

    New investors are unable to compare their results the currently available options


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