06/09/2010

David Swensen, the Yale Endowment Manager, proposed this one size fit in all model portfolio for individual investors. The major difference between this portfolio and other conventional portfolios is that it emphasizes international equities (including emerging market equities) as well as real estate investment. Compared with various diversified portfolios, an interesting asset class missing is the commodities, which has been considered to be an excellent anti-inflation diversifier. This is complemented with its emphasis on the inflation-protected treasury bonds. In the model portfolio constructed, we assume annual rebalance although Swensen actually pointed out that in Yale's institutional portfolio, they rebalanced daily, which, by his estimate, gave about 1-2% of excessive returns vs. annual rebalancing.

Compared with the Simpler Is Better (SIB) portfolios we discussed in the previous article, Swensen excluded commodities while putting emphasis on using fixed income for the purposes of inflation protection and portfolio hedging. Since commodities ETFs and index funds are still problematic (see this article), Swensen's six assets are the most investable assets.

Note: it has been confusing whether Swensen advocated using long term treasury bonds or just an average duration treasury bonds. In his book Unconventional Success: A Fundamental Approach to Personal Investment, he wrote "The purity of noncallable, long-term, default-free Treasury bonds provides the most powerful diversification to investor portfolios". Based on this sentence, it has been interpreted that he meant to use the long term treasury bond. However, recently, a reader posted a reply from David Swensen on this question in morningstar.com that indicates the average duration of treasury bonds.

The portfolio consists of the following:

• 30% in Vanguard Total Stock Market Index (VTSMX or Vanguard ETF VTI)
• 20% in Vanguard REIT Index (VGSIX or Vanguard ETF VNQ)
• 20% in Vanguard Total International Stock (VGTSX) or (15% in VGTSX or Vanguard ETF VEU and 5% in VEIEX or Vanguard ETF VWO)
• 15% in Vanguard Inflation Protected Securities (VIPSX or iShares Tip TIP)
• 15% in Vanguard Long Term Treasury Index (VUSTX or iShares TLT or Vanguard ETF EDV)

We have constructed both index fund based and ETF based plans using the above funds. Model portfolios using MyPlanIQ Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA) are generated. The following compares the Swensen's portfolio with SAA moderate and TAA moderate model portfolios.  Since the ETF based plan has shorter history, we present here the index fund based portfolios.

labels:investment,ETF,

Symbols:spy,efa,eem,iyr,dbc,agg,vti,veu,vwo,vnq,bnd,icf,gsg,vt,wfvk,VTSMX,VGSIX,VGTSX,VIPSX,VUSTX,

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06/03/2010

Selecting the right funds in a portfolio strategy is critical for both self-directed investors and administrators of retirement plans such as 401(k) and IRAs. Working with too few funds limits diversification benefits and limits opportunities. On the other hand, too many funds can be confusing and misleading. Getting the right mix is especially important in a retirement plan as participants have a wide range of differing requirements and demands that will drive their financial planning.  For ETF investors,  the ever increasing number of ETFs (the latest tally is $782 billion asset in 810 funds) only exacerbates this problem. 

MyPlanIQ has developed guidelines for providing the optimal investment choices for an ETF based plan or a portfolio. The following are the key criteria to consider when making such choices.

Diversification

Candidate funds should cover major asset classes at least. We consider the following the major classes.

• US Equity
• Developed Country Equity (ex. US)
• Emerging Market Equity
• Real Estate Investment Trusts (REITs, most US)
• Commodities
• Fixed Income

For global investors, we add Foreign Fixed Income as another major asset. Minor assets and styles are also possible candidates if strategies employed handle them effectively. We do not advocate going down to sector or industry levels since their volatile and concentrated nature defeats the diversification purpose

Fund Qualities

Since most ETFs are index funds, the following should be used to select an ETF.

• Liquidity: The minimum requirement should be at least 250K daily average volume in last 3 months – exclude ETFs with low trading volume. The other major factor to consider is the total net asset an ETF is held. In general, we would prefer at least $1 billion asset for a major ETF.
• Tracking error: how closely it tracks its stated index benchmark.  Price/Nav discount/premium and bid-ask spreads are two important factors to consider here. In general, for two ETFs that have the same stated index benchmark, the one has tracks the benchmark more closely should be picked.  
• Fee: all things equal, low expense fee is a key advantage for a long term portfolio. Vanguard ETFs and index funds have set high standard/bars for other ETFs to measure up to.
• Return: again, all things equal, return is another factor to use to distinguish ETFs.

Portfolio Building

In addition, it is critical to see how these selected funds work with each other. For example, consider the following two choices: US Equity, Emerging Market Equity and Fixed Income vs. US Equity, Developed Country Equity and Fixed Income. How would these asset classes work together? How would the actual funds behave when putting them together? MyPlanIQ uses a proprietary method to perform historical simulation to evaluate portfolio effectiveness.

Let’s try to select candidate ETFs for a simple core portfolio that consists of 6 key major assets mentioned above. We will build two funds – the one we think is the best and compare it with the most popular in each asset class.

US Equity: there are plenty choices here. The first comes to mind is the Wilshire 5000 Total Return index. Claymore launched an ETF (WFVK) to track this index in March 2010. However, since this is a fairly new ETF, its trading volume is light and thus is excluded. The other venerable index would be Vanguard Total Stock Market Index ETF (VTI). Its average daily trading volume in the past 3 months is more than 2 million shares. Another choice is the oldest and most popular S&P 500 ETF: SPDR SP 500 (SPY). This is the most liquid ETF and it has the least bid-ask spread. It has more than 200 million shares change hands daily. SPY, however, is a large cap index, not a broad base index. We prefer VTI over SPY.

Developed Market Equity: MSCI EAFE index (EFA) and Vanguard FTSE All-World ex-US ETF (VEU) are the two candidates. Vanguard Total World Stock (VT) is a one for all equity ETF that covers all of three equity asset classes (U.S. Developed and Emerging Markets). We prefer VEU over EFA, considering the low expense Vanguard charges for VEU.

Emerging Market Equity: iShares MSCI Emerging Market Index (EEM) and Vanguard Emerging Market Equity (VWO) are the two candidates. Matt Hougan from IndexUniverse and others have written several articles discussing both ETFs. Again, Vanguard VWO is clearly a winner after taking cost into account.

Real Estate Investment Truse (REITs): Dow Jones U.S. Real Estate Investment Trusts (IYR) is the most popular while iShares Cohen & Steer Realty Majors (ICF) is more concentrated on major REITs. Vanguard REIT Index ETF (VNQ) has the lowest expense, wide diversification and high trading volume. VNQ is clearly the choice here.

Commodities: Powershares DB Commodity Index ETF (DBC) and iShares S&P GSCI Commodity Index (GSG) are the two main choices. It is interesting to see that DBC has higher expense (1.3%) than GSG (0.75%) while GSG is more concentrated on energy commodities (74% vs. 55%). In general, DBC is more balanced though GSG has wider exposure among many commodities. This article has some more detailed writeup on the comparison between the two ETFs. DBC, though not as diversified as GSG, is more balanced in major commodities. We prefer DBC.

Fixed Income: for a broad base fixed income exposure, iShares Barclays (Lehman) Aggregate Bond (AGG ) and Vanguard Total Bond Market (BND) are the clear two candidates. With its lower expense cost (0.11%), BND is better than AGG (0.2% expense). This article compares the two ETFs in more detail.

MyPlanIQ has created two plans for the core portfolios. The candidate funds for Six Core Asset ETFs Most Popular are chosen  based on their popularity (history and liquidity). The candidate funds for the other plan Six Core Asset ETFs are chosen  based on more detailed criteria outlined above. The following table shows the selections of the two plans:

The following table shows the performance of model portfolios: one Strategic Asset Allocation (SAA) Moderate and one Tactical Asset Allocation (TAA) Moderate portfolio are chosen for each plan.

From the above table, one could clearly see that the selection of candidate funds for constructing a portfolio plays an important role in portfolio returns. The 2-3% difference of annualized returns in the past 5 years between the two corresponding portfolios is striking. It clearly shows that it pays to put more efforts in selecting funds.

The impressive performance of Six Core Asset ETFs supports the maxim ‘simpler is better’.

labels:investment,ETF,

Symbols:spy,efa,eem,iyr,dbc,agg,vti,veu,vwo,vnq,bnd,icf,gsg,vt,wfvk,

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12/03/2010

This report reviews Aflac Incorporated 401(k) Savings and Profit Sharing Plan plan. We will discuss the investment choices and present the plan rating by MyPlanIQ. Current economic and market conditions are discussed in the context of the investment portfolios in the plan. We will then show how participants in Aflac Incorporated 401(k) Savings and Profit Sharing Plan can achieve reasonable investment results using asset allocation strategies.

Plan Review and Rating

AFLAC Inc (Ticker:AFL) has the "Aflac Incorporated 401(k) Savings and Profit Sharing Plan".

Aflac Incorporated 401(k) Savings and Profit Sharing Plan's 401K plan consists of 11 funds. These funds enable participants to gain exposure to 3 major assets: US Equity, Foreign Equity, Fixed Income. The list of minor asset classes covered:

Foreign Large Blend: EFA, VEU, GWL, PFA
Intermediate-term Bond: AGG, CIU, BIV, BND
Large Blend: IVV, IYY, IWV, VTI, VV, SPY, DLN, RSP, SCHX
Large Growth: IVW, IWZ, JKE, VUG, ELG, QQQQ, RPG, SCHG
Large Value: IVE, IWW, JKF, VTV, ELV, PWV, RPV, SCHV
Mid-cap Growth: IJK, IWP, VOT, EMG, PWJ, RFG, UKW
Moderate Allocation: AOM
Small Growth: IJT, IWO, JKK, VBK, DSG, PWT, RZG, UKK

As of Dec 2, 2010, this plan investment choice is rated as based on MyPlanIQ Plan Rating methodology that measures the effectiveness of a plan's available investment funds. It has the following detailed ratings:

Diversification -- Rated as (35%)
Fund Quality -- Rated as (33%)
Portfolio Building -- Rated as (36%)
Overall Rating: (35%)

Current Economic and Market Conditions

We have experienced an uncertain 2010: plenty of worries on whether the US economy will climb out of the great recession and recover.

• The Federal Reserve embarked on Quantitative Easing II (QE2) to stimulate the economy.
• The housing market is still at its low but largely stabilized.
• The unemployment rate is stuck at 9%.

Americans continue to face an uncertain future, given (among others) the high unemployment rate, large federal and local government debts and global trade imbalance. With such an economic backdrop, the stock and debt markets are going to be volatile. Despite this, markets have been resilient and appear positioned to rebound.

In this market it is even more critical to properly diversify and respond market changes. MyPlanIQ offers two asset allocation strategies: strategic and tactical asset allocation strategies ( SAA and TAA for participants in Aflac Incorporated 401(k) Savings and Profit Sharing Plan).

Strategic Asset Allocation is based on well known modern portfolio theory and its key features include: diversification, proper fund selection and periodically re-balancing.

Tactical Asset Allocation works on a diversified array of assets provided by funds in a plan and adjusts asset mixes based on market conditions such as asset price momentum utilized by TAA.

Portfolio Discussions

The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies. For comparison purpose, we also include the moderate model portfolios of a typical 3 asset SIB (Simpler Is Better) plan . This SIB plan has the following candidate index funds and their ETFs equivalent:

US Equity: (SPY or VTI)
Foreign Equity: (EFA or VEU)
Fixed Income: (AGG or BND)

Performance chart (as of Dec 2, 2010)

Performance table (as of Dec 2, 2010)

Currently, asset classes in US Equity (SPY,VTI), Foreign Equity (EFA,VEU) and Fixed Income (AGG,BND) are doing relatively well. These asset classes are available to Aflac Incorporated 401(k) Savings and Profit Sharing Plan participants.

To summarize, Aflac Incorporated 401(k) Savings and Profit Sharing Plan plan participants can achieve reasonable investment returns by adopting asset allocation strategies that are tailored to their risk profiles.

Symbols: AFL , SPY , VTI , EFA , VEU , AGG , BND , AOM , CIU , BIV , GWL , PFA , IVE , IWW , JKF , VTV , ELV , PWV , RPV , SCHV , IVV , IYY , IWV , VV , DLN , RSP , SCHX , IVW , IWZ , JKE , VUG , ELG , QQQQ , RPG , SCHG , IJK , IWP , VOT , EMG , PWJ , RFG , UKW , IJT , IWO , JKK , VBK , DSG , PWT , RZG , UKK

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