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No Portfolio is Complete Without…

investment portfolio strategies

investment portfolio strategiesFor the past two years I have been reviewing mutual funds to invest in. I have formulated a set of criteria for specific mutual funds, and a set of parameters for how a new mutual fund should fit into an overall portfolio. Additionally I have set periods of time to change a mutual fund’s distributions from ‘reinvest’ to ‘cash distribution.’ Here are a few of the criteria, parameters and scheduling points:

  • 4 or 5 Star Morningstar rating (Strong Historical Rating)
  • No Front End Load
  • Expense Ratio Under 1.5% (favor expense ratio under 1%)
  • No, Or Minimal Exposure to Companies Who Received Large Bailouts
  • Inclusion of Mutual Funds That Went Up During the 2009 Downturn, Like Nothing Was Happening
  • Selection of Multiple Funds From Various Fund Families, With Multiple Well Rated Funds
  • Exposure to Bond Funds, Equity Funds & Funds With Stocks & Bonds
  • Selection of A Few Funds With Top Holdings I Had No Exposure To
  • Attempt to Allocate So As Not to Sell the Entire Mutual Fund, Unless It No Longer Meets Criteria
  • Begin to Set Dividends to Pay Cash Post 2012 Presidential Election

In my opinion no portfolio is complete without exposure to strong mutual funds, the reason is simple: diversity. I could sit around every day reviewing companies, and investing in them, and I still would not have exposure to every single great company worth investing in. When I invest in a mutual fund, I can gain exposure to many companies’ stocks and bonds in one swoop. Though I believe no portfolio is complete without strong mutual funds, I have recently found value in mutual funds that hold several mutual funds: Funds of funds. At first I did not think they were as important as I now believe they are, so in this article I will go over some benefits of these specialized mutual funds, and go over a few examples of funds of funds.

Funds of Funds

I have suggested mutual funds to investors recently, and wrote an article detailing one of the responses; a newer investor stated he did not want to pay anything extra for others to manage his portfolio. My reply was, “if the fund is making you money, what difference does it make?” In fact I have found that mutual funds have the potential to outperform allocations to several stocks with strong fundamentals.

Of course a mutual fund can underperform too, even one that looks like it has many strong qualities. A lot depends on the overall direction of the market, though currently more investors are seeing profit in their portfolios. Investors who have little to no exposure to mutual funds may consider allocating some profit to strong funds of funds.

Rebalancing: Moving Some Profit To Funds With More Equity

Recently I went through my mutual funds and pulled some profit from one fund of funds (a target retirement mutual fund) that holds more bonds than stocks and redirected the profit into another fund of funds that holds more stocks than bonds. I already held both of these mutual funds, so what I really did was rebalance my holdings. Had I sold the entire mutual fund I would have secured all of the profit, though I would have lost exposure to the funds’ holdings.

I basically skimmed the profit from the target retirement fund so it is back down to the amount I originally allocated. I should note I try to invest at least 10% more than the fund’s minimum to begin with, so the holding hopefully will not go into a range where I may be charged extra fees. Some fund families charge an annual fee, if the balance falls below a certain point, this point is sometimes well below the minimum required to invest; for instance if the fund’s minimum is $2,500, I try to allocate $2,750, the fund may have a $2,000 minimum before an extra fee is added.

I should also note a very important detail, the fund of funds I directed profit to — the one with more stocks than bonds — has a lower expense ratio than the fund I moved out of. So, even though the market is at an all-time high, and I don’t necessarily want to dive into overpriced stocks (not that all stocks are necessarily overpriced) I do feel I made a cost effective decision, and am hopeful that even if the stock market hits turbulence the fund I directed profit to will be able to accumulate more shares at lower prices. I should also add, that my ultimate plan is to move funds from this mutual fund into another mutual fund that holds even more stocks and fewer bonds, over time. While I plan to do this, I hope to simultaneously invest in individual corporate bonds which may offer higher yields when rates go back up. Here is a recap:

  • I’ve gradually set some mutual funds to pay distributions in cash, rather than reinvest
  • I’ve drawn profit from funds of funds that performed well and directed it to funds of funds with slightly more equity exposure
  • I have set my sights on a traditional mutual fund that holds stocks and bonds, to hopefully direct profit to over the course of the year
  • I hope to accumulate cash distributions, in order to buy new corporate bonds in the next few years
  • I hope the cash generated from these funds, and individual bonds will help counteract any possible stock market downturn

I do not view this strategy as ‘timing the market‘ rather as a sort of ‘continuous allocation strategy.’ Though it is on a much smaller scale, I believe this is a similar approach to the great investors and businesspeople who try to grow their portfolios quarterly, and annually. If the mutual funds I profit took from go up more, great; if they go down and continue to meet my criteria, I may invest back into them.

No Portfolio is Complete Without Funds of Funds & A Strategy

Some investors feel their portfolio is complete when they have 10 or 20 stocks. Some investors have 5 mutual funds and that’s it. I believe each investor needs to compose their portfolio the way they see fit. Though, I’d pose, that I personally believe investors can benefit from a couple mutual funds that hold multiple mutual funds.

It is important to discuss these funds with the fund family to inquire about expense ratios. In some cases a fund of funds’ expense ratio is the average of all the mutual funds it holds; while some may have one expense ratio for their fund of funds, the mutual funds within the fund have additional expenses (notice the table below shows both the gross and net expense ratios.) Overall I believe the funds of funds with the lowest expense ratio are most appealing, though investors should also weigh the fact that one fund of funds can provide exposure to many investments they may not be able to get individually. This may be because:

  • Investments in all of the mutual funds on their own would be cost prohibitive
  • Because a fund of funds may hold mutual funds that are closed to new investors
  • or because the fund of funds holds institutional class shares, often not available to retail investors (the retail class shares may have front end loads, while the institutional class shares may not)

Here are a few examples of funds of funds:

 Morningstar RatingNet AssetsTop 5 HoldingsStocks / BondsExpense Ratio (Gross/Net)
American Century LIVESTRONG Income (ARTOX) *Name changing to OneChoice May 31st 2013
 **** $447M
  1. American Century NT Diversified Bond I (retail shares have front end load, the instl class shares have a $5M minimum)
  2. American Century NT Large Company Val I
  3. American Century NT Equity Growth Instl (retail shares have front end load)
  4. American Century Infl-Adj Bond Instl
  5. American Century International Bd Instl (retail shares have front end load)
 44% / 41% 0.77% / 0.21%
Aston/Lakepartners LASSO Alternatives N (ALSNX) ****$320M
  1. Robeco Long/Short Eq I
  2. Weitz Partners III Opportunity Instl
  3. JHancock2 Global Absolute Rtrn Strats I
  4. FPA Crescent
  5. Metropolitan West High Yield Bond I
 38% / 25% 3.3% / 1.45%
Fidelity Freedom 2030 (FFFEX) *** $10.5B
  1. Fidelity Series Investment Grade Bond
  2. Fidelity Series Commodity Strategy
  3. Fidelity Series High Income
  4. Fidelity Growth Company
  5. Fidelity Series International Value
 48% / 25% 0.71% / 0.71%
iShares S&P Growth Allocation (AOR) **** $178M
  1. iShares Core S&P 500 ETF
  2. iShares Core Total US Bond Market ETF
  3. iShares MSCI EAFE Index
  4. iShares Core S&P Mid-Cap ETF
  5. iShares Barclays Short Treasury Bond
 58% / 30% 0.31% / 1.12%
iShares S&P Moderate Allocation (AOM) *** $183M
  1. iShares Core Total US Bond Market ETFi
  2. Shares Core S&P 500 ETF
  3. iShares Barclays Short Treasury Bondi
  4. Shares MSCI EAFE Index
  5. iShares iBoxx $ High Yield Corporate Bd
 42% / 39% 0.31% / 1.37%
MH Elite Fund of Funds (MHEFX)
 ** $8M
  1. PIMCO Fundamental IndexPLUS TR Inst
  2. Wells Fargo Advantage Growth Adm
  3. Weitz Partners III Opportunity Instl
  4. Brown Advisory Growth Equity Inv
  5. Sterling Capital Equity Income Instl
 77% / 6%2.2% / 1.25%
T. Rowe Price Personal Strategy Balanced (TRPBX) **** $1.8B
  1. T. Rowe Price Instl Emerging Mkts Bond
  2. T. Rowe Price Instl High Yield (closed)
  3. T. Rowe Price Instl Emerging Mkts Eq
  4. T. Rowe Price Instl Intl Bond
  5. T. Rowe Price Real Assets
  6. Apple Inc.
  7. US Treasury Note 0.875%
  8. Google Inc.
 63% / 30% 0.87% / 0.63%
USAA Managed Allocation (UMAFX) **** $666M
  1. iShares iBoxx $ Invest Grade Corp Bond
  2. Vanguard FTSE Emerging Markets ETF
  3. iShares MSCI EAFE Index
  4. iShares Barclays 1-3 Year Credit Bond
  5. iShares Core S&P Mid-Cap ETF
 50% / 35% 0.99% / 0.74%
 Vanguard STAR (VGSTX) **** $15B
  1. Vanguard Windsor II Inv
  2. Vanguard Short-Term Investment-Grade Inv
  3. Vanguard GNMA Inv
  4. Vanguard Long-Term Investment-Grade Inv
  5. Vanguard International Value Inv
 60% / 35%0.34% / -*

All of these funds happen to have varying degrees of weight towards equity, though there are several funds of funds with more exposure to bonds. The attributes that conflict with my criteria are highlighted in red. To search for more funds on your own, try entering ‘allocation’ into  Yahoo! Finance, then ‘show all results.’ Check the funds’ holdings; several mutual funds with ‘allocation’ in their name are funds of funds. Additionally several ‘retirement income funds’ and ‘target date’ mutual funds hold several mutual funds.

You will notice some of these only hold mutual funds within their own family, they are fettered; whereas funds that hold other fund families are unfettered. I included the iShares ETFs in this example as well, interestingly you see the USAA mutual fund holds several iShares ETFs; its net expense ratio turns out to be lower than the iShares ETFs in this list. Notice I listed more top holdings of the T. Rowe fund, since it holds individual stocks, in addition to several T. Rowe mutual funds.

Taking the Review Process A Step Further

The Aston/Lakepartners LASSO Alternatives fund holds mutual funds I like; however, its gross expense ratio is well above my limit. The fund’s net expense ratio is just under my limit, therefore I could consider the fund. To take the process one step further, I checked Aston/Lakepartners LASSO fund’s recent performance and top holding, Robeco Long/Short Equity (BPLSX). Aston/Lakepartners has lagged the market’s overall performance YTD (notice it keeps a lot of cash on the sidelines,) its inception date was March 2010, so there is no long-term track record. The fund’s top holding, Robeco Long/Short Equity I is rated 5 stars and has a $100,000 minimum; however its gross expense ratio is 4.29%, its net expense ratio is 2.48%.  You see, the fund of funds meets my criteria, just barely, given its 1.45% net expense ratio, though the top holding does not; I have reservations about the fund due to its lagging YTD performance, though I will continue to watch it. The one reason I’m leaning towards investing in the fund is the fact it could close to new investors at some point.

Each fund’s net expense ratio is linked in the table above, in most cases the net expense ratio is lower than the gross expense ratio. The iShares ETFs’ net expense ratios are higher than their gross expense ratios. The net expense ratio often fluctuates from year to year, while the gross expense ratio is determined by the fund, it too can fluctuate. You must also read the fine print, notice the Vanguard STAR fund’s net expense ratio is not listed; I called Vanguard and a representative said the listed gross expense ratio is calculated, at least in part, as an average of all the funds held in the STAR fund. Vanguard customers should be aware:

“(Vanguard charges) a $20 annual account service fee for each Vanguard fund with a balance of less than $10,000 in an account. This fee doesn’t apply if you sign up for account access on Vanguard.com and choose electronic delivery of statements, confirmations, and Vanguard fund reports and prospectuses. This fee also doesn’t apply to members of Flagship®, Voyager Select®, and Voyager Services®.”

Similar caveats may exist for many mutual funds, so it is important to read the information, and consult the brokerages. Additionally, it is wise to check the fund’s statistics on its home page and on Morningstar from time to time; it is possible a change could be made that would be either favorable (such as an expense ratio reduction) or unfavorable (such as a new fee being applied for certain conditions, major changes in the fund’s composition or performance.)

Once you’ve reviewed this class of mutual funds, taken a look at the fund’s prospectus and decide whether the investment works for your portfolio. At first I did not see much value in ‘funds of funds’ though I have grown to appreciate them. Whether a portfolio is viewed in $1, $100, $1,000 or greater increments; allocation to greatly diversified funds such as these has the potential to maximize the reach of your portfolio’s dollars, in terms of exposure to many different funds and fund managers.

Disclaimer: This article is not a recommendation to buy or sell, please consult a financial adviser to determine proper allocations (if any) to meet your financial objectives. I am long ARTOX, Fidelity Freedom Funds, TRPBX and VGSTX; I am now long ALSNX and am considering a long-term investment in iShares S&P Growth Allocation (AOR).

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Just an average investor... primarily in American equity and bonds. (Important Note: My articles, blogs, comments, reference links and messages are not intended to be investment advisements; or to value securities. Examples and considerations are hypothetical and educational. Please consult a financial advisor before making investments in any security. Thank you for reading!)