Revised Model Fund Portfolio: Benchmark Impacted by Cap Weighting

The Model Fund Portfolio increased nicely over the past three months and is now up 11.5% year-to-date as of September 30, 2012.

However, the S&P 500 index, as measured by the Vanguard 500 Index fund (VFINX), is up 16.3.% over the same period, outpacing every one of the funds in the portfolio. VFINX is even ahead of Guggenheim S&P 500 Equal Weight fund (RSP), which is rather unusual since the equally weighted RSP exchange-traded fund consistently outperforms the capitalization-weighted VFINX mutual fund, as you can see by comparing their three-, five- and nine-year results in Table 1.

The one time that the cap-weighted model is sure to work best is when the heaviest weighted holding [Apple Inc. (AAPL), 4.4% of VFINX] goes up over 60%. Apple had a fantastic run and Google Inc. (GOOG) also helped. Unlike the tech bust of the early 1990s, AAPL and GOOG are not high price earnings ratio stocks, and both could go to $1,000 per share without high price-earnings ratios, but not without risk.

There was an amazing consistency in the returns of the funds in the Model Fund Portfolio. We had no super-performing fund, and only FMI Common Stock fund (FMIMX) was significantly lower. When new money is added to a fund, research shows that the stocks purchased with those inflows outperform stocks bought later on to replace them. This would suggest that funds with new money flowing in will perform better. This is a problem when funds close to new investors, as FMIMX has. However, over the long term there is an advantage in not having to buy stocks when you have already bought all the stocks that fit your criteria.

Figure 1. Model Fund Portfolio vs. Benchmark (through 9/30/12)

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