Model Fund Portfolio: Replacing a Closed Fund

There was a slight pullback in January: The year-to-date return for the Model Fund Portfolio was –2.0%, as of January 31. The S&P 500 index pullback in January, as measured by the Vanguard 500 Index fund (VFINX), was –3.5%. January is usually a strong up month, but at least part of the pullback can be attributed to the strong up market and investors waiting until after the year end to sell and realize profits.

Figure 1 charts the cumulative return. Returns for various time periods are shown in Table 1, and Table 2 gives the year-by-year performance figures and growth of $10,000.

Portfolio Changes

We have sold Yacktman Focused fund (YAFFX) and replaced it with Fidelity OTC fund (FOCPX).

We felt that Yacktman Focused fund was reaching the size where it would become a closet index fund, and the 1.25% expense ratio was just too high. Fidelity OTC fund is one of the few funds that currently meets our criteria, and it provides a broadening of our holdings. There is no rush to sell the Yacktman fund if you are just short of the one-year capital gains holding period.

Closed Funds

The Yacktman fund was one of three holdings in the Model Fund Portfolio closed to new investors. The other two are Aston/Fairpointe Mid Cap N fund (CHTTX), which closed last quarter, and FMI Common Stock fund (FMIMX), which closed at the end of 2009.

For those using the Model Fund Portfolio as a guide for their investments, these two funds should continue to be held by those who currently own them. Anyone not owning them and unable to buy them now should simply use the remaining seven funds. They provide ample diversification.

I have a personal belief that successful fund managers are constantly looking for stocks with real potential for their portfolios and are able to find them. To take advantage of such discoveries, new cash is required or old holdings need to be sold. When a fund closes to new investors, cash inflows are reduced (there still are some inflows from existing shareholders), and history shows that managers are not good at selecting which stocks to sell. So I believe there is a negative effect.

There may also be a positive effect in that managers are not forced to invest more than they are comfortable investing, but I feel this advantage would only be significant for small-cap funds. It is hard to understand why Yacktman Focused, which invests in giant-cap stocks, would need to close. Since Aston/Fairpointe Mid Cap just closed, we can’t look for any impact. But FMI Common Stock is showing some weakness, and I believe it is a result of the fund closing.

The All-ETF Portfolio

As explained in my November 2013 column, we are now tracking a portfolio made up of only the exchange-traded funds (ETFs) in the Model Fund Portfolio. Comparing the performance of these two portfolios (Tables 2 and 3), the All-ETF Portfolio outperformed the Model Fund Portfolio in 2013. The holding of Fidelity Capital & Income fund (FAGIX) makes the Model Fund portfolio more conservative, and the downside of being conservative is underperformance in up markets. The fund was up during a generally down January.

It is also interesting to note that our real estate holding, Vanguard REIT Index fund (VNQ), had a weak 2013 but has started to move up, as we felt it might. This exchange-traded fund is the best performer year-to-date as of January 31 in the Model Fund Portfolio, although one month does not offset a long weak spell.

The debate continues as to whether the extra return a great fund manager can produce is enough to overcome the higher expense ratio and more frequent transactions with higher transaction costs. There is also the rather significant factor of tax management, for investments outside of a retirement plan. Exchange-traded funds have significant advantage there. We will be observing and comparing the Model Fund Portfolio and the All-ETF Portfolio through the months and years to come.

Outlook

January was down, but after a very strong up year investors who wished to take profits could have deferred the tax obligations by waiting until January to sell. The stock market never goes up every day, week, month, or year, so there will be some pullback during 2014 even if it is an up year.

There is also the possibility that the economy could stagnate and 2014 could be a down year. But as of this writing in early February, things look pretty good for the economy and corporate profits are above expectations. The consensus is that it will be a modest up year with volatility along the way. But we are all long-term investors, so it doesn’t matter, right?

The next Model Fund Portfolio column will be in the May AAII Journal. You can keep up with the portfolio at AAII.com.