The market continued to stay positive in the second quarter, but has yet to show any indication of a superior year.
The Model Fund Portfolio is up 2.9% year-to-date as of June 30, 2016, compared to 3.8% for the S&P 500 index as represented by the exchange-traded fund SPDR S&P 500 ETF (SPY).
There are no changes in the holdings of the Model Fund Portfolio this month. However, there are changes in the rationale, which will likely bring about changes in the holdings in the near future. I discuss this after I introduce a new portfolio that is replacing the alternative All-ETF Portfolio.
This new portfolio, which is called the Level3 Passive Portfolio, is based on research carried out for the writing of my forthcoming book “Investing at Level3” (www.level3investing.com). It is an ETF portfolio of index funds meant to be:
The characteristics of the Level3 Passive Portfolio are:
The ETFs that make up the Level3 Passive Portfolio are described in the Investment Rationale and Processes section on the next page. I have appended “passive” to the portfolio name because my book also describes “active” Level3 portfolios that involve individual stock selection.
Table 1 shows the funds and their performance over the very short term since this portfolio’s inception on June 1, 2016.
Because the Level3 Passive Portfolio provides an approach for investors who do not wish to spend the time or effort to select individual stocks or non-index mutual funds based on factors that change over time, the Model Fund Portfolio will take a more aggressive approach. Funds and ETFs selected will be based on their manager’s skill in adapting to markets and whether they are investing in areas of strength in the intermediate term.
This may require more frequent changing of holdings than occurred in the previous approach.
Table 1. Level3 Passive Portfolio
| Fund (Ticker) | Weight | Return % Since5/31/2016 |
Guggenheim S&P 500 Equal Weight  (RSP) |
40% | -0.09 |
|
PowerShares Russell 1000 Equal Weight (EQAL) |
20% | 0.56 |
|
Vanguard Mid-Cap Value (VOE) |
20% | 0.29 |
|
Vanguard REIT Index (VNQ) |
20% | 6.89 |
| Weighted Avg of ETFs in Portfolio* |
|
1.51 |
| Actual ETF Portfolio** |
|
1.39 |
|
Comparison: SPDR S&P 500 (SPY) |
0.25 | |
|
*A weighted average return of the ETFs in the current Level3 Passive Portfolio. **Performance of actual Level3 Passive Portfolio, including reinvested dividends. Source: Morningstar, Inc. Portfolio inception date 6/1/2016. Data as of 6/30/2016. |
||
I think we now know who will be our candidates for the presidency. However, as of this writing just before the conventions, there are still some theories about possible changes.
Both candidates have been fairly clear on income tax issues, but political party platforms and the make-up of the House and Senate would have significant impact on any president’s plans for changing the tax code. There probably won’t be much change unless the Democrats should win the presidency and both houses. In that case, we would probably see higher tax rates, but only for the wealthy. We would also likely see higher estate and gift taxes. If the Republicans win both houses and the presidency, we would see corporate taxes go down and fewer brackets for individual taxes with slightly lower rates. Within each party, there are wide differences of opinion.
Personally, I still think this is likely to be an above-average year in the equity market. However, there are vulnerabilities with domestic and international terrorism. In addition, if Mother Nature continues the way she is going, the economic impact could be significant. Please keep up with the model portfolios at AAII.com until my next column in the November AAII Journal.
This portfolio is intended to be either the complete equity portfolio for those investors who wish to manage their own portfolio but do not choose to be involved in individual stock selection or one portion of a whole portfolio for those who may wish to select individual equities and actively managed funds on a limited basis but keep the majority of their portfolio in index funds.
The portfolio consists of index ETFs that should have, based on their approach, returns above that of the S&P 500 index. As a portfolio, it is more diversified than the S&P 500, which should reduce portfolio downturns that are based on the impact of a few sectors.
Portfolio changes should be relatively rare and will occur only when a new or different ETF is felt to be more effective at accomplishing a similar objective than one of the current holdings. There are some new index ETFs with promising approaches, but there will be at least a year of observation before they can be considered.
Four ETFs make up the Level3 Passive Portfolio. The weights of the holdings in the portfolio are very likely to change over time based on experience.
A more thorough discussion of the ETFs in the Level3 Passive Portfolio and other new funds that might qualify when they have sufficient volume and history are discussed in my book “Investing at Level3.”
Note: The Vanguard Mid-Cap Value ETF (VOE) is being held in the Level3 Passive Portfolio, but the Guggenheim S&P MidCap 400 Pure Value ETF (RFV) is being retained in the Model Fund Portfolio. The difference between the two funds is slight. Since the Model Fund Portfolio may be experiencing other changes soon, the decision was made to leave it as is for now.
Guggenheim S&P 500 Equal Weight ETF (RSP)
This exchange-traded fund has outperformed the cap-weighted S&P 500 index over the 13 years of its existence. Other indexes also indicate that equal weighting provides higher returns. Equal weighting gives more weight to value stocks and smaller-cap stocks in an index, which leads to superior performance over the long run.
This fund, because of its size and history, is given a portfolio weight of 40%.
PowerShares Russell 1000 Equal Weight ETF (EQAL)
This ETF includes the top 1,000 stocks by capitalization size and gives some exposure to mid-cap stocks. Mid-cap stocks historically have had higher returns than large caps. It is a new fund, however, and uses an innovative approach that needs some observation before comparing it to Guggenheim S&P 500 Equal Weight ETF.
For now, it is weighted at 20% of the portfolio.
Vanguard Mid-Cap Value ETF (VOE)
Mid-cap value has had higher returns than large stocks or mid-cap growth stocks.
It is weighted at 20% of the portfolio.
Vanguard REIT Index (VNQ)
The returns of real estate investment trusts (REITs) have exceeded the returns of the S&P 500 over the long run and provide diversification as well.
This ETF is weighted at 20%.
The new approach to the Model Fund Portfolio will be more aggressive than in the past, including switching some holdings over those with an intermediate-term focus. The portfolio will focus on:
Portfolio changes will only be made every three months, as in the past, but changes will be posted the evening of the change here.
For the Model Fund Portfolio, the initial holdings are equally weighted. For the Level3 Passive Portfolio, the initial weightings are as previously indicated and as shown in Table 1. The approach to rebalancing in both cases is to keep it to a minimum. While momentum is less of a factor with funds than it might be with stocks, and transaction costs for funds are much less than for stocks, rebalancing frequently is a distraction and can make taxes a significant consideration.
You should be able to achieve almost all the rebalancing necessary when you add and withdraw funds or when changes are made in the holdings. In the 12 years of the Model Fund Portfolio, no rebalancing has been thought as necessary to do. If over time a holding gets significantly out of line, adjustments can be made.
Decisions will have to be made by the individual since every investor will have added assets at a different time, so everyone’s weights will be different. But the following are general guidelines:
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