It’s a rather poor year for the stock market, and the worst of it has come in the last three months.

The Model Fund Portfolio and the S&P 500 index [as measured by the Vanguard 500 Index fund (VFINX)] were both up about 1% year-to-date on June 30. Through September 30, the S&P 500 is down 5.4% and the Fund Portfolio is down even more, at –8.5%.

The bull market that usually appears in the year before a presidential election is nowhere to be seen, although there are three months left in 2015. The theory has been that the politicians spend the time just before an election to influence votes and that boosts the economy—or appears to. Nothing in Washington, either from the Congress or the Federal Reserve, seems to be helping the economy, but the fact that nothing is happening may be a long-term blessing.

Figure 1. Model Fund Portfolio vs. Comparison (through 9/30/2015)

The performance of the individual funds and exchange-traded funds (ETFs) can be seen in Tables 1 and 3. Long-term performance is shown in Table 2. Aston/Fairpointe Mid Cap fund (CHTTX) continues the slide that began with its closing to new investors, and it is now the weakest performer this year. iShares MSCI Frontier 100 ETF (FM) also got hit significantly, due to the drop in oil prices. Even Fidelity Capital & Income (FAGIX), which tends to be less volatile, is down slightly for the year to date.

There are no changes in the Model Fund Portfolio or the All-ETF Portfolio. There are also no changes in the portfolio rules.

ETF Problems

While there has always been a difference between the net asset value and the market value of ETFs, it has been trivial for the popular index ETFs and modest for most others.

However, the market versus asset values separated dramatically in an extremely fast down market on August 24, 2015. I saw differences of 20% in even the most popular ETFs, such as the price of SDPR S&P 500 ETF (SPY) compared to the S&P 500 index real value. That means that some buyers made 20% in a few minutes and some sellers received 20% less than they theoretically should have.

How could this happen? The two forces that keep the market price of an ETF close to its true value (based on the value of the securities it represents) could not respond fast enough to keep up with “at the market” sell orders. Trading units in ETFs are created by buying equivalent underlying assets and this keeps the price and the asset value close. In addition, in any market such as this, there are arbitragers who will buy and sell mispriced assets for a small profit, thereby keeping disparities small. Neither of these processes was able to react fast enough to keep up with “at the market” sell orders.

Table 1. Model Fund Portfolio

										Std	Worst
										Dev	3-Yr
		Market	YTD	Annual Return (%)				Fund	Exp	(36 Mo.	Cal
		Cap	Return	1-	5-	10-	Since	Assets	Ratio	Ann’l)	Period
Type	Fund (Ticker)	Size	(%)	Yr	Yr	Yr	6/30/2003	($ Mil)	(%)	(%)	(%)
MF	Aston/Fairpointe Mid Cap N (CHTTX)*	Large-Cap	-14.7	-10.9	10.7	9.0	10.3	1,756.7	1.11	13.5	-7.9
MF	Fidelity Capital & Income (FAGIX)	****	-1.0	-0.5	7	8.0	8.6	10,482.2	0.72	5.3	-7.2
MF	Fidelity OTC (FOCPX)	Large-Cap	-2.1	3.6	16.0	10.9	11.6	8,610.9	0.83	13.5	-8.3
ETF	First Trust US IPO (FPX)	Large-Cap	-2.8	2.0	19.1	nmf	nmf	752.5	0.60	13.1	-13.7
ETF	Guggenheim S&P 500 Equal Weight (RSP)	Large-Cap	-7.2	-1.6	13.3	7.7	9.7	9,023.1	0.40	10.1	-11.4
ETF	Guggenheim S&P MidCap 400 Pure Value (RFV)	Mid-Cap	-10.7	-4.8	11.4	nmf	nmf	98.2	0.37	13.1	-4.3
ETF	Guggenheim S&P SmCap 600 Pure Value (RZV)	Small-Cap	-14.6	-7.3	11.4	nmf	nmf	145.0	0.36	16.3	-7.9
ETF	iShares MSCI Frontier 100 (FM)	Large-Cap	-14.3	-24.6	nmf	nmf	nmf	485.8	0.79	12.8	nmf
ETF	Vanguard REIT Index (VNQ)***	Large-Cap	-4.3	9.3	11.9	6.9	10.3	24,529.5	0.12	14.3	-11.9
Avg of Funds in Actual Model Fund Portfolio†			-8.0	-3.9	12.6	8.5	10.1	6,209.3	0.59	9.7	-9.1
Actual Fund Portfolio Performance††			-8.5	-4.3	10.0	5.8	7.9	—	—	9.7	-6.4
Optional Investment:
ETF	iShares Barclays 1-3 Year Treasury Bond (SHY)	Bonds	0.9	1.1	0.6	2.4	2.8	13,111.1	0.15	0.5	1.3
Comparison:
MF	Vanguard 500 Index (VFINX)	Giant-Cap	-5.4	-0.8	13.2	6.7	7.8	24,972.5	0.17	9.7	-8.4
*CHTTX is closed to new investors. Current shareholders can continue to invest in the fund. Other investors should simply use the other eight funds to form their portfolio. ** Distressed securities - stock and bond. ***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 9/30/2015.

Table 2. Model Fund Portfolio Annual Performance

	Average Annual Return (%)		Cumulative Growth 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	12.6	15.8	20,075	17,589
2013	26.7	32.2	25,436	23,250
2014	9.9	13.5	27,962	26,388
2015 YTD**	-8.5	-5.4	$25,590	$24,967
Since Incep**	7.9	7.8	$25,590	$24,967
*June 30 to December 31, 2003. **Through September 30, 2015. Portfolio was started on June 30, 2003.

Table 3. Alternative All-ETF Portfolio

	Weight*	YTD Return (%)	Annual Return (%)
			1- Yr	Since 12/31/2012
Fund (Ticker)
First Trust US IPO ETF (FPX)	20%	-2.8	2.0	18.9
Guggenheim S&P 500 Equal Weight (RSP)	20%	-7.2	-1.6	14.0
Guggenheim S&P MidCap 400 Pure Value (RFV)	20%	-10.7	-4.8	11.2
Guggenheim S&P SmCap 600 Pure Value (RZV)	20%	-14.6	-7.3	9.1
iShares MSCI Frontier 100 (FM)	10%	-14.3	-24.6	4.2
Vanguard REIT Index (VNQ)	10%	-4.3	9.3	9.3
Weighted Avg of ETF Funds in Portfolio†		-8.9	-3.9	12.0
Actual ETF Portfolio††		-8.9	-4.1	11.4
Comparison: Spider S&P 500 (SPY)		-5.3	-0.7	13.6
* Weights were adjusted at the close of 9/30/2014. ** A weighted average of the ETFs in the current All-ETF Portfolio. *** Performance of actual All-ETF Portfolio, including reinvested dividends. Source: Morningstar, Inc. Data as of 9/30/2015.

Various steps have been taken to eliminate or reduce this problem. The most effective one is probably the creation of computer programs that will try to take advantage of this mispricing to make a profit, which would reduce the arbitrage opportunity and the mispricing. But such programs may not work perfectly.

In addition, it is hoped that ETF investors will have learned not to place market sell orders in this kind of market. I hope that it was not individual investors who got stung badly, but rather computerized trading systems.

If you are prone to panic, ETFs may not be your best investment choice. Remember that the popular index ETFs will be the least impacted in a fast market and the less popular indexes will be more vulnerable. Even more vulnerable will be actively managed ETFs.

Looking Forward

There are still a number of conflicting forces impacting the market. The most bearish factor to me is the recent reduction in overall corporate profits. The most bullish factor is the growing number of loud growling bears.

Perhaps we will have a better picture of the serious contenders for president next March when our next Model Fund Portfolio article appears. In the meantime, you can follow the portfolio here.