Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, September 30, 2013. You can also find the re-balance calendar for 2013 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.

Please note that we now list the next re-balance date on every portfolio page.

Feature Change

We have removed ‘Follow’ feature/button on a portfolio page. The reason we are deprecating this ‘Follow’ feature is to make sure a model portfolio users follow is in sync with his/her actual account, in terms of fund holding period calculation. When you follow an existing portfolio and start to purchase its current holdings in your actual account, the holding period for the fund you just purchase is going to be different from that in the existing model portfolio. This can create problems going forward, especially for mutual fund based portfolios. To accommodate this, we believe the best way is to follow a newly customized portfolio (from the existing model portfolio you want to mirror) which only start to count the holding periods today, similar to the funds you purchase in your account (assuming you don’t delay the purchase). 

For existing ‘followed’ portfolios, this removal will not affect your current model portfolios (listed on your ‘Dashboard’). This will only affect any new usage. So whatever you have been following, this feature change will have no effect. 

Fixed Income No More?

The term ‘fixed income’ has a warm and fuzzy meaning to many income investors, especially for retirees and baby boomers. As we have been so fixated and used to the steady coupons and capital gains delivered by bonds, it is hard to believe that this is coming to end. The following chart shows the total return of Vanguard total bond index fund (VBMFX) since 1990:

Since 6/5/1990, VBMFX has had 6.4% annualized return. However, recent weakness has brought down its 1,3,5,10 year returns: 

 Inception (6/5/1990)
  1 Yr 3 Yr 5 Yr 10 Yr Inception** YTD*(2013)
Annualized Return(%) -2.7 2.4 4.5 4.5 6.4 -3.5
Sharpe Ratio -0.9 0.64 1.04 0.81 0.56 -1.44
Draw Down(%) 5.2 5.2 5.2 5.4 6.5 5.2

The ending or unwinding of the unprecedented loose monetary policies in the past has posed two big challenges to this generation of income investors:

  • Volatility is going to increase: because of the over leveraged financial system and the unstable equilibrium (see, for example,  September 9, 2013: The New Normal and Portfolio Risk Management), fixed income is increasingly behaving like equity. Traditionally, fixed income bonds are considered to be a safe haven because most recessions and financial shocks in the past were caused by normal boom and bust business cycles. However, with global financial systems impaired so much by loose and junk credits, unwinding them will cause upheavals in precisely their sources — debt markets. So get ready for more volatile fixed income investments. Year to date, VBMFX has 5.2% maximum drawdown, only slightly better than 5.4% in 2008 and the worst one 6.5% in 1994. 
  • The 6% total return will be hard to get: with trailing 12 month yield being as low as 2.9% and the sub zero interest rate, it is hard to see that bonds will continue to deliver that stellar 6% return in the coming years. Investors are now between a rock and a hard place: if you decide to go for longer term mature bonds for higher yields, you might get crushed by the upcoming inflation; if you go for higher yield junk bonds, you might equally get hurt by more frequent recessions that are induced by credit problems. 

Tactical Capital Returns and Yields

However, it is not hopeless to still get a reasonable return from fixed income investments, as we pointed out several times in the past (see March 18, 2013: Are Bond Investors Doomed?).  However, the extra returns have to come from a more active or tactical approach to take advantage of opportunities in various bond segments. We don’t believe that a simple indexing buy and hold approach will deliver that extra returns. 

We are agnostic to any forecast. However, we don’t dismiss this outright either, especially for those long term forecasts from some reliable sources. In fact, it provides a framework for us to work through our analysis.  At the moment, GMO forecasts that bonds will deliver 0.2% annualized real return (i.e. in excess over inflation) in the coming 7 years (see GMO’s Latest 7 Year Asset Class Return Forecast: Not Optimistic). That translates to roughly 2-3% nominal return. 

It is also well known that there are some great fixed income investors who have consistently deliver higher returns over benchmark indices. In fact, they are at least more consistent than those in equity investing. These managers include Bill Gross, Dan Fuss and Jeffrey Gundlach. Academic research also indicates that momentum effects in bond investing can be exploited (see Derwall, Jeroen and Huij, Joop, ‘Hot Hands’ in Bond Funds). 

There are two ways to take an active tactical approach in bond investing:

In a word, investors should start to get used to a more total return oriented approach instead of just yield/interest chasing. You can see some discussion on this topic in August 5, 2013: Total Return vs. High Yield Investing

Should You Join the Great Rotation?

Recently, there have been some chatters on so called ‘Great Rotation‘, first coined by Bank of America Merrill Lynch. Income investors and other investors alike are forced to chase risk asset returns because of record low bond yields. Should you join this?

The answer is NO. Even though we believe (well that is only belief) that in the coming years, bonds are going to suffer from high volatility and low returns, we don’t believe that tells us we should abandon the basic risk profile principle, i.e., stocks and bonds are two fundamentally different asset classes that are both needed in constructing a sound portfolio. Setting up a proper risk profile for one’s portfolio is still the most important step one should take in portfolio construction, regardless whether you are using SAA or TAA. 

However, it is always our position that investors should only be 100% in  fixed income allocation for very few situations such as a very short term purpose for the money. Even for retirees, some limited equity exposure can actually help to improve your returns and risk! See June 18, 2012: Reasonable Returns Don’t Need To Come With Excessive Risk or May 27, 2013: Conservative Allocation Mutual Fund Portfolios

Finally, just as what we mentioned above, fixed income investing is becoming more and more like stock investing: experts are now constantly appearing in Twitter or CNBC, touting their opinions (think about Bill Gross’ Twitter feeds or Gundlach’s webcast). For that, we remind our readers not to fall into an old saying “do as I say, not as I do”. 

Portfolio Performance Review

We review total return bond fund portfolios and conservative allocation fund portfolios (Fixed Income Bond Fund Portfolios and  Conservative Allocation Fund Portfolios): 

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR
Schwab Total Return Bond 0.5% 3.7% 5.8% 8.1% 6.6%
Fidelity Total Return Bond 0.5% 3.7% 5.8% 8.9% 7.0%
TDAmeritrade Total Return Bond 0.3% 3.2% 6.3% 8.7% 7.1%
FolioInvesting Total Return Bond 0.5% 3.7% 5.8% 8.0% 6.5%
Etrade Total Return Bond 0.5% 3.7% 5.6% 7.8% 6.4%
PTTRX (PIMCO Total Return Instl) -3.6% -1.4% 3.5% 6.7% 6.1%
VBMFX (Vanguard Total Bond Market Index Inv) -3.5% -2.7% 2.4% 4.5% 4.5%
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR
Schwab Conservative Fund Upgrade 4.3% 4.7% 5.6% 7.3% 6.6%
Fidelity Conservative Fund Upgrade 2.0% 1.9% 5.8% 7.0% 6.8%
TDAmeritrade Conservative Fund Upgrade 2.0% 2.4% 5.0% 6.3% 6.2%
ETrade Conservative Fund Upgrade 5.7% 6.3% 5.5% 7.7% 7.3%
BERIX (Berwyn Income) 10.8% 13.1% 8.5% 9.3% 7.9%
VWINX (Vanguard Wellesley Income Inv) 4.5% 5.5% 8.7% 8.3% 7.1%

**YTD: Year to Date

Returns (AR: Annualized Return) include dividend/interest reinvested. More detailed portfolio info.

For fixed income side, these brokerage specific portfolios have been in cash for some time now, avoiding the bond debacle. On the other hand, the conservative allocation portfolios have been steady even though one can see that all of them under performed BERIX (Berwyn Income), a solid conservative allocation fund. However, readers can see from the detailed info link that these portfolios have only 7-9% maximum drawdown, compared with 16.8% of BERIX. 

Market Overview

Other than commodities, all other risk asset classes are now exhibiting positive trends. Given the Yellen-Summers next Fed chairman selection drama, markets are showing more excitement. However, these are all transitory events that have no bearings on our investing strategies. What we do know is that stocks are expensive, bonds are expensive and no assets exhibit great values (other than some very limited sectors) at the moment.  

For more detailed asset class trends, see  360° Market Overview.

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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