Re-balance Cycle Reminder
Based on our monthly re-balance calendar, the next re-balance time will be on Monday, November 19, 2012. You can also find the re-balance calendar of 2012 on ‘Dashboard‘ page once you log in.
As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.
Also please note that we now list the next re-balance date on every portfolio page.
Conservative Allocation And Income Portfolio Review
For income oriented investors, especially for retirees and conservative investors, current market conditions are not favorable, to say the least. Global banks around the world have adopted so called low rate or in the US, zero rate policy to prop up economies. By doing so, it punishes savers and income investors, the so called ‘financial repression’. Federal reserve bank has enticed or forced conservative investors to take much more risk.
You hear constantly from media that the golden era for fixed income investment is over, the long 20 years bull market in bonds is over. What to do?
Well, it turns out the situation is not really hopeless, at least for conservative investors who are willing to take more active roles in an array of diversified assets. We believe that if you are willing to adopt a systemic but conservative investing strategy over a spectrum of risks in fixed income assets, reasonable returns can still be obtained.
So what are the asset classes in the fixed income areas that can help to counter the current financial repression:
- high yield bonds: with super loose and accommodative monetary policies from the central bank, companies can obtain credits more easily. Low grade companies such as those small cap companies can finance their operations through junk bond issuing. High yield (or junk) bonds have exhibited strong and reliable momentum, as shown by our advanced portfolios such as P High Yield Bond Alpha VWEHX. This renders high yield bond funds as good candidates for a trend following strategy.
- Long term bonds in TIPs (inflation protected bonds), Treasury and corporate bonds: long term bonds have played important roles in a permanent portfolio (see All Weather Portfolio Construction Part 1: Permanent Income Portfolio) or risk parity based all weather portfolio (see Ray Dalio’s All Weather Portfolio: A Variation of Permanent Portfolio). Both Harry Browne and David Swensen have advocated using long term bonds as an insurance for a portfolio (see, for example, David Swensen Six ETF Asset Individual Investor Plan). Given exceptional low yields in the long term bonds, however, one has to be careful, especially in using them statically in a strategic asset allocation portfolio. We would feel more comfortable in using them in a tactical or trend following portfolio to take advange of these bonds’ strength when present.
- International and emerging market bonds: two reasons to have these bonds as portfolio building candidates: 1). U.S. dollar weakness as the loose monetary policy adopted by the Federal Reserve bank and the U.S. government debt issue have driven U.S. dollar valuation steadily lower for the past 10 years. It is thus a good hedge to have exposure in foreign bonds that are denominated in local currencies. 2). The past decade has seen emerging market economies have risen to rival developed markets. In fact, many emerging market countries such as China, Brazil and Russia have sovereign debts that are much more sound (at least based on reported data). Emerging market debts have high yields. We again feel investing in these bonds warrants an active or tactical approach.
Of course, all of the above bonds are sitting on the riskiest end of the fixed income risk spectrum. These assets are not going to rise forever, there will be up and down periods. In fact, at the moment, we see very little value in high yield and long term bonds. The key here is to capture these bond assets intermediate trends. Bond asset rotation can help. Diversification also helps: constructing a fixed income portfolio that has some limited exposures into these riskier bond assets is one way to hedge out risks among inflation, deflation and currency depreciation.
To invest in bond portfolios with the above diversification, the best way is to invest in a so called total return bond fund that can invest in various bond assets (or categories). To further counter bond managers’ risk, one can use fund selection to weed out under performer in a period. See P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly.
As illustrated in our previous newsletter: , adding some stocks (such as 10-25%) to a portfolio can actually lower the overall portfolio risk while maintaining or increasing the overall portfolio returns. These portfolios are often characterized as ‘conservative’ portfolios. One way to invest in such these portfolios are through excellent conservative mutual funds. Fortunately, there are still several such excellent funds. To mitigate fund managers’ risk, again, one can adopt a fund ungrading portfolio that essentially selects one or a few top funds from a dozen of excellent conservative or total return bond funds. See P No Load Conservative Mutual Funds Upgrading Quarterly.
The following compares the 3 representative portfolios that are mentioned above:
Portfolio Performance Comparison (as of 10/19/2012)
| Ticker/Portfolio Name | 1 Week Return* |
YTD Return** |
1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe | 10Yr AR | 10Yr Sharpe |
|---|---|---|---|---|---|---|---|---|---|---|
| P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly | 0.4% | 7.4% | 8.8% | 287.2% | 8.7% | 212.5% | 9.9% | 200.0% | 11.3% | 214.2% |
| P No Load Conservative Mutual Funds Upgrading Quarterly | 5.6% | 10.4% | 10.1% | 158.7% | 6.9% | 112.1% | 7.7% | 120.1% | 9.3% | 139.7% |
| Permanent Income Portfolio | -0.1% | 6.4% | 10.5% | 267.7% | 10.0% | 190.0% | 6.8% | 92.0% | 7.7% | 109.1% |
*: NOT annualized
**YTD: Year to Date
See the latest and detailed comparison >>
All in all, we are still confident that even in the coming years that are supposed to be a low interest rate and much riskier bond investing environment, a diversified and conservative portfolio or active management of bond or conservative funds can still help fixed income or conservative investors greatly.
Market Overview
We observed an interesting and not insignificant development in last week: U.S. stocks are now ranked lower than international developed market stocks (EFA). Furthermore, commodities have been weak (ranked at the bottom in the major asset trend table on 360° Market Overview. Furthermore, long term Treasury bonds (IEF) have now ranked below total return bond index (BND).
We don’t know whether this is yet another re-enforcement of showing stock markets’ strength or it is just a temporary blip. For now, we believe our portfolios are positioned well.
See 360° Market Overview for more asset class trends.
We remain deeply skeptical on this rally.
We again copy our position statements (from previous newsletters):
Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible.
We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.
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Diversified Asset Allocation Portfolios For Your Plans
