Equal-Weighted ETF Helps Boost Model Fund Portfolio Return

The Model Fund Portfolio, which three months ago was trailing the Vanguard 500 Index fund (VFINX) by 5%, just about caught up to the broad market for the year, finishing 2012 up 15.5% compared to a 15.8% return for the index fund.

Year-to-date through January 31, 2013, the Model Fund Portfolio has pulled ahead again by a bit, with a return of 5.3% compared to 5.2% for the Vanguard 500 Index fund. Much of this is due to the run up and run down of Apple Inc. (AAPL). With Apple at more typical growth levels, our portfolio’s S&P 500 exchange-traded fund holding, the Guggenheim S&P 500 Equal Weight fund (RSP), reestablished dominance over the Vanguard 500 Index fund over both the long and short term, as can be seen in Table 1.

Figure 1 shows the cumulative return of the Model Fund Portfolio since its inception in June 2003 compared to the Vanguard 500 Index fund. Table 2 gives year-by-year return figures.

Portfolio Composition

There are no changes in the portfolio this month. I have had a number of emails indicating that investors prefer exchange-traded funds (ETFs) because of the flexibility, the low expense ratios and, above all, the better control of tax liability. I believe our Model Fund Portfolio will gradually move toward holding more ETFs as we get more portfolio history, but unless the rules change, there will always be some areas of profit opportunity that don’t fit the ETF model.

Figure 1. Model Fund Portfolio vs. Benchmark (through 1/31/13)

 

I am hoping that the movement by investors toward ETFs will encourage traditional mutual funds to cut their expenses. There is no reason for an established fund to have an expense ratio over 1.00%, and the larger funds could be well below that. I understand that fund management is a business, and managers want to maximize profit. Only if investors become more sensitive to costs and vote with their feet will profit maximization and lower fees come together.

Outlook

We have at least a temporary decision on taxation rates. Dividends, for now, remain taxed at a reduced rate, and only interest income faces the full earned income tax rate. In general, it will remain better to have stocks in non-deferred accounts and debt instruments sheltered in deferred accounts.

I continue to have a bullish bias on the Model Fund Portfolio and probably will until the market reaches its historical highs, whenever that may occur. It may occur before you read this, but historically February has not been a great month. While the economy looks a bit better both here and abroad, there are still many concerns. One cannot help but wonder what will happen when the Federal Reserve slows down its easing and interest rates start to rise. Over the long term, the T-bill rate has matched inflation, which it is not doing now.

In my Shadow Stock Portfolio column in the January 2013 issue of the AAII Journal, I mentioned that post-election years have, on average, been the weakest with a 6.7% average since the 1930s. However, 2009 was a notable exception, with the Vanguard S&P 500 index fund up 26.5% and the Model Fund Portfolio up 24.9%, the best year in its 10-year history.

Also, with Baltimore and San Francisco both being old NFL football teams, the NFL indicator was up no matter which team won the Super Bowl this year. I am not much of a believer in historical indicators and will wait and see.

The next Model Fund Portfolio column will be in the June AAII Journal. In the meantime, you can keep abreast at AAII.com in the Model Portfolios area.