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AAII Model Portfolios

No Reason to Switch Funds in the Model Fund Portfolio

Aston/Fairpointe continues to have one of the highest long-term returns, while none of the competitors to our funds or ETFs justify making a change.

by James B. Cloonan | May 2015

Featured Tickers:

The Model Fund Portfolio continues to lead the S&P 500 index, as measured by the Vanguard 500 Index fund (VFINX).

The Model Fund Portfolio has gained 2.6% year to date as of March 31, 2015, compared to a gain of 0.9% for the Vanguard 500 Index fund. Unlike at the time of our last column in March, both are positive for the year, but not dramatically so.

The alternative subset of the Model Fund Portfolio invested in only the exchange-traded funds (the All-ETF Portfolio) also leads the Vanguard 500 Index fund at 2.5% year to date. The results for longer periods for both portfolios can be seen in Figure 1 and Tables 1, 2, and 3.


Figure 1. Model Fund Portfolio vs. Comparison
(through 3/31/2015)
Figure 1. Model Fund Portfolio vs. Comparison (through 3/31/2015)

Small and mid-cap stocks have begun to come back; they are currently ahead of the general market and appear to be strengthening even more.

The iShares MSCI Frontier 100 ETF (FM) is the poorest-performing fund in the portfolio so far this year. It had a double hit: Many of the frontier stocks are oil-related, which had a negative impact, and the strong dollar has hurt almost all foreign stocks. I still believe that the impact will moderate and that over the long term, these smaller-country stocks will provide a strong growth opportunity.

The performance of the Vanguard REIT Index ETF (VNQ) has moderated a bit since March, but the real estate sector still continues to be one of the strongest sectors for the year.

The Portfolio

There are no changes in the Model Fund Portfolio or the subset All-ETF Portfolio. Several of the ETFs have competitors, but there is no reason to change any holdings at this point.

I indicated previously that Aston/Fairpointe Mid Cap fund (CHTTX) might see a performance drop when it closed to new investors, and there is some indication that this is happening. My thinking was based on various research indicating that fund managers are much better at picking stocks to buy with new funds than they are at selecting stocks to sell. It seems the stocks they choose to sell perform better subsequently than those chosen to replace them.

Table 1. Model Fund Portfolio


 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 6/30/2003
Type
MF Aston/Fairpointe Mid Cap N (CHTTX)* Large-Cap 2.3 7.0 14.9 11.2 12.3 2,430.9 1.11 13.4 (7.9)
MF Fidelity Capital & Income (FAGIX) na** 4.0 7.0 9.1 9.0 9.4 10,985.0 0.73 5.0 (7.2)
MF Fidelity OTC (FOCPX) Large-Cap 4.8 18.4 17.6 12.8 nmf 9,197.5 0.77 14.0 (8.3)
ETF First Trust US IPO (FPX) Large-Cap 7.1 18.0 21.6 nmf nmf 610.7 0.60 12.4 (13.7)
ETF Guggenheim S&P 500 Equal Weight (RSP) Large-Cap 1.7 12.8 15.5 9.5 11 11,197.7 0.40 10.2 (11.4)
ETF Guggenheim S&P MidCap 400 Pure Value (RFV) Mid-Cap 1.2 8.0 12.9 nmf nmf 120.4 0.37 13.6 (4.3)
ETF Guggenheim S&P SmallCap 600 Pure Value (RZV) Small-Cap 1.1 2.3 12.6 nmf nmf 175.4 0.36 16.9 (7.9)
ETF iShares MSCI Frontier 100 (FM) Large-Cap (2.0) -5.3 nmf nmf nmf 574.5 0.79 nmf nmf
ETF Vanguard REIT Index (VNQ)*** Large-Cap 4.7 24.1 15.8 9.9 nmf 28,835.1 0.10 13.2 (11.9)
Avg of Funds in Actual Model Fund Portfolio†   2.8 10.3 15.0 10.5 10.9 7,125.2 0.58 12.3 (9.1)
Actual Fund Portfolio Performance††   2.6 9.1 12.3 7.7 9.3 — — 9.3 (6.4)
Optional Investment:
ETF iShares Barclays 1-3 Year Treasury Bond (SHY)   0.5 0.9 0.9 2.5 2.9 7,739.2 0.15 0.6 1.3
Comparison:
MF Vanguard 500 Index (VFINX) Giant-Cap 0.9 12.6 14.3 7.9 8.8 28,368.9 0.17 9.5 (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 including reinvested dividends.
nmf = no meaningful figure.

Source: Morningstar, Inc. Data as of 3/31/2015.

Aston/Fairpointe Mid Cap fund has dropped a bit in assets, from $2.496 billion to $2.431 billion, because of closing. However, it is still one of the top-performing funds over the long run, and we believe that those who own shares should continue to hold the fund at the present time.

Our newest exchange-traded fund, First Trust US IPO (FPX), added in February of 2014, has the best performance of our holdings in 2015 so far. It has been an exceptional performer since it started five years ago, and we hope there won’t be too many copycats fighting over the same holdings.

Table 2. Model Fund Portfolio Annual Performance

  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 12.6 15.8 20,075 17,589
2013 26.7 32.2 25,436 23,250
2014 9.9 13.5 27,962 26,390
2015 YTD** 2.6 0.9 28,688 26,632
Since Incep** 9.3 8.8 28,688 26,632
*June 30 to December 31, 2003.
**Through March 31, 2015. Portfolio was started on June 30, 2003.

Table 3. Alternative All-ETF Portfolio

 
YTD Return (%) Annual Return (%)
 
1-Yr Since 12/31/2012
Fund (Ticker) Weight*
First Trust US IPO ETF (FPX) 20% 7.1 18.0 76.4
Guggenheim S&P 500 Equal Weight (RSP) 20% 1.7 12.8 49.4
Guggenheim S&P MidCap 400 Pure Value (RFV) 20% 1.2 8.0 51.2
Guggenheim S&P SmallCap 600 Pure Value (RZV) 20% 1.1 2.3 50.6
iShares MSCI Frontier 100 (FM) 10% (2.0) (5.3) 22.2
Vanguard REIT Index (VNQ) 10% 4.7 24.1 40.9
Avg of ETF Funds in Portfolio†
1.3 8.4 42.9
Actual ETF Portfolio††
2.5 10.4 50.6
Comparison: Spider S&P 500 (SPY)   (3.0) 12.6 50.7
* Weights were adjusted at the close of 9/30/2014.
†An average of the ETFs in the current Model Fund Portfolio.
††Performance of actual ETF Portfolio including reinvested dividends.
Source: Morningstar, Inc. Data as of 3/31/2015.

Outlook

Nothing much has changed at the macro level since March. The economy seems to be growing, but not as fast as predicted or hoped. Though the Federal Reserve is still hard to read, the odds seem to favor interest rate expansion beginning this year, likely in the fall. However, the increases may be very gradual. The stock market keeps pushing against record highs but can’t seem to make a sustained run.

We are entering the electioneering phase of our democracy. The Democratic Party seems to have only one candidate, but the Republican Party has legions and we have a year and a half to learn their names. This is “promise them anything” time, and we will see how it affects the stock market. Historically it has pushed the market up, but we will have to wait and see if this time will be different.

Our next column on the Model Fund Portfolio will be in the August AAII Journal, but you can follow it and the Model Shadow Stock Portfolio at AAII.com.

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.

Discussion

BJ from CA posted over 11 years ago:

How does one get started in Model Fund portfolio?


Zachariah Tripp from NH posted over 11 years ago:

@BJ- just buy equal amounts of the funds that are still open to new investors. You want want to research the initial purchase amounts to ensure you have enough starting capital. In regards to the ETFs, find the broker that offers most of the commission free. Even a $7 commission can add up if you are dollar cost averaging monthly.


Zachariah Tripp from NH posted over 11 years ago:

I am not sure if I understand the purpose of the model fund portfolio or what AAII is trying to achieve with it. Couple comments/concerns: 1. I do not believe the S&P 500 (VFINX) is the correct benchmark for a portfolio of funds that include largecap, midcap, smallcap, REIT, and international holdings. Wouldn’t the Total Market Index (VTSMX) be better? Or even a asset allocation fund, like one of Vanguard’s LifrStrategy Fund (VASGX). 2. In the management rules, I do not see any criteria for manger tenure and we know that actively managed mutual fund historical returns are only as good since the current manger took over the ship. Also in regards to the management rules, what are the sell rules? 3. Wouldn’t a diversified index fund approach have just as good returns with less actively managed fund risk? There are plenty of index fund portfolios out there today that backtest and beat the S&P 500 over long periods of time. 4. All three of these portfolios have outperformed the S&P 500 and the AAII actively managed fund portfolio since July-2003. A. 33.3% VFINX + 33.3% VEXMX + 33.3% NAESX = 226% B. 26.66% VFINX + 26.66% VEXMX + 26.66% NAESX + 20% VGSIX = 218% C. 16.66% VFINX + 16.66% VEXMX + 16.66% NAESX + 16.66% VGSIX + 16.66% VGENX + 16.66% VGHCX = 259% Personally, I would rather see AAII focus it’s efforts in reviewing, highlighting and reporting the performance of various portfolios that are already established. Like “lazy portfolios” or the 7-12 portfolio. Possibly even sector-rotation or momentum style portfolios. Something that is not already available. Here is a link to a Google Docs file with the three portfolios listed above. All data is sourced from Yahoo! Finance used “Adj. Close Price” Link: https://drive.google.com/file/d/0B4If9paaULUaOE5yVXZlbzhmZjg/view?usp=sharing Portfolio A is labeled Portfolio 1 in the graph. If is equal weighted S&P 500, Exteneded Market (Modcap + Smallcap), and Smallcap Portfolio B is labeled Portfolio 2. It is weighted 80% Portfolio 1 plus 20% REIT. Portfolio C is labeled Portfolio 3. It is equal weighted S&P 500, Extended Market, Smallcap, REIT, Energy, Healthcare. Notice, Portfolio 3 never lost value.


Neil Schecker from PA posted over 11 years ago:

Hi Zachariah Great chart...any chance you could add a spreadsheet that shows yearly returns for each portfolio and the VFINX, especially portfolio #3? Thanks, Neil


Dave Gilmer from WA posted over 11 years ago:

James, I am not exactly sure this quote of yours: "The Model Fund Portfolio continues to lead the S&P 500 index, as measured by the Vanguard 500 Index fund (VFINX)." is the best to lead out with when the Model Portfolio has underperformed the VFINX index in all 3 time periods involved - 1 year, 5 year, and 10 year! Sure if you got in within the first two years you are still a little ahead (.5%) but what has it done for us in the last 10 years - nothing! Dave


Tom from CA posted over 11 years ago:

Is anyone else confused by Table 2? It seems logical to use the intersection of the row “Since Inception**” and the 4th column to find the value of the model fund on 3/1/2015 ($25,436) and the intersection of the same row and the 2nd column to find the average annual return (9.3%) since 6/30/2003 (11.75 yrs). Using those numbers results in a model portfolio valuation of $28,431, $2,995 more than the value shown. However, if you use a return of 9.38% over 11.75 years, you get a valuation of $28,688 the value in the fourth column of the row “2015 YTD**”. It seems that the 28,688 in the “2015 YTD” row should be exchanged with the 25,436 in the “Since Incep** row” and the same exchange made with the 26,632 and 23,250 values. I found the price of VFINX to be $71.61 on 6/30/2003 and $190.71 on 3/31/2015, which results in an average return of 8.69% which is very close to the 8.8% in Table 2, further evidence that the Table 2 contains errors.


Hareesh Jayanthi from IL posted over 11 years ago:

Thanks Tom for the comment. Your numbers for the bottom row are correct. That is an error on the table and our apologies for that. Thank you for pointing that out.


Zachariah Tripp from NH posted over 11 years ago:

@Neil- I have uploaded a new file with some additional information. Please remember, data is sourced from Yahoo! Finance, I do not know how actual it is. I do not take responsibility for Excel errors, i believe my formulas to be correct. Finally, returns are very sensitive to start and stop dates. These returns are from starting on 01-July-2003 because that is where AAII's graph starts. Since 2003 has "only" been 12 years. Link: https://drive.google.com/file/d/0B4If9paaULUadGlQNUhwS21kUzA/view?usp=sharing


Robert Scudero from VT posted over 11 years ago:

Are the funds and etf's in the model fund portfolio equal weight? BobS


Charles Rotblut from IL posted over 11 years ago:

Robert, An investor who is starting to follow the portfolio should put equal dollar amounts in each fund. The Model Fund Portfolio itself is not routinely rebalanced. -Charles


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