2013 Tom Madell, Ph.D.

Apr. 2013

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Mutual Fund/ETF Research Newsletter


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Do Record Highs Tempt You to Change Course?

By Tom Madell

Not much has changed in the last few months to alter my view that stocks will continue to be the best place for long-term investors over at least the next several years. Even at record levels, most categories of stock funds do not appear overvalued, and some appear to be significantly undervalued. (These valuation levels are reflected in my specific updated Stock Model Portfolio recommendations and suggested weightings for each presented in this Newsletter.)

Obviously, this column's title reflects one of the most challenging questions that many investors now face. But, just as obviously, there is no one answer to fit all investors.

Of course, for some investors this is not an issue at all. They merely start with some pre-determined allocation to stocks; it could be as high as 100% or as low as zero, but is typically about 50 to 60%. They now, as before the current stock surge, essentially just hold on to their initially chosen portfolio investments. If and when any replacements are made, they mostly switch to highly similar types of funds (i.e. a stock fund is replaced with another stock fund, as opposed to a bond fund, or cash.) An additional strategy they might use is to periodically rebalance, bringing their stock allocation back to where it began if it has grown.

Such an approach can have its benefits, freeing one from having to make difficult allocation-altering decisions. But these investors must be able to hold their stock allocation steady during a bear market,

continued on page 5

New April 2013 Model Portfolios

The main thing that may have changed since my Jan. Model Portfolio is that many, or most, bond fund categories seem more and more unlikely to deliver the kind of returns investors have achieved in recent years. Given this fact, and what I think is the small possibility that some of these categories may fizzle out altogether, I am lowering the bond allocation, but only for highly risk averse (Conservative) investors. However, if I had to guess, I would still expect the best bond funds to beat out money market funds (with essentially zero returns) by several percentage points over the course of this year.

Likewise, I have also dropped my allocation to stocks by a tad for Conservative investors, while increasing cash. This does not represent an endorsement for holding cash, but only suggests that with risk levels somewhat higher for both bonds and stocks, cash is one of the only places left if one is convinced that risk assets may possibly lose value.

But for all those investors who systematically rebalance, rising values for stocks since the first of the year might suggest the need to sell off some stocks just to stay even with your January allocation.

Overall Allocations to Stocks, Bonds, and Cash

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 67.5% (67.5%)
Bonds 27.5 (27.5)
Cash 5 (5)
For Aggressive Risk Investors
Asset Current (Last Qtr.)
Stocks 85% (85%)
Bonds 10 (10)
Cash 5 (5)

continued below

Page 2

Apr 2013

(New April 2013 Model Portfolios, continued from page 1)

For Conservative Investors
Asset Current (Last Qtr.)
Stocks 45% (47.5%)
Bonds 35 (45)
Cash 20 (7.5)
Note: If you are very risk adverse,
you obviously might want less
in stocks.

Model Stock Fund Portfolio Recommendations

In my Model Portfolios, I recommend specific stock funds I feel investors should invest in, and in what specific proportions within your portfolio. Obviously, if you are already invested in a fund and are satisfied with the results thus far, or even if you think your fund will eventually prove its worth, then treat my suggestions as just that. The main reason I provide these specific recommendations is that I would like readers to do as well as possible. My research on which specific funds to invest in has gone on for many years. While not exhaustive and not intended to find the absolute highest performers (which frequently have very high risk), the research has led me to believe that the chosen funds are not only the best ones for me to personally invest in, but probably, for most others too.

I am suggesting several changed funds within my Model Portfolio. I feel we have entered a period where category choices within the stock fund realm will lead to larger and larger differing levels of return as compared to the last 4 or 5 years of relatively non-differentiated returns. (You may wish to read what I said on this subject back in Oct. 2010.) For example, domestic Value-oriented funds have returned on average about 16% over the last 12 months; domestic Growth-oriented funds only about 10%.

In my largest allocation category, International Stocks, I am adding a fund, Vanguard Pacific Index (VPACX), investing in the Asia/Pacific region with a current rather huge (59%) position in Japan. Such an selection would be mainly for relatively aggressive investors. As risky as that might sound, the fund has actually outperformed the S&P 500 index on an annualized basis over the last 10 years, even though Japan's stock market was hurt badly by the 2011 earthquake/tsunami and continued to be slow to recover until around mid-2012.

Japan, with a newly elected leader, is on the cusp of taking aggressive steps, similar to the "quantitative easing" of the US and Britain, to right their economy which has been floundering for more than a decade. After all the missteps, they finally seem to have a grasp of what not to do, and so are ready to embark on that corrective path. We have already seen have how such policies have juiced the US's and Britain's stock markets in spite of their oft-struggling economies.

In the Large Value category, a fund that has been been doing quite well, especially over the last three years, is Vanguard US Value (VUVLX). It is run by a highly experienced and successful manager who also manages the Vanguard Equity Income Fund (VEIPX), also a highly successful fund which we have previously recommended. As I pointed out in the March Newsletter, Large Value (including Financials) seems to be poised to outperform, so we are recommending a fund that seems capable of doing that. VUVLX has outperformed 97% of its peers over the last year, returning more than 6% better than its category average with a one year total return of over 21%.

As I also said in my March Newsletter, Global Real Estate along with Financials, are sector funds I believe are the most undervalued. Therefore, I have replaced our US-only Real Estate fund, Vanguard REIT (VGSIX), with a fund that invests worldwide, namely Third Avenue Real Estate Value Fund Investor Class (TVRVX). (If you wish to keep your choice within the Vanguard group, you might try Vanguard Global ex-US Real Estate Index (VGXRX), although the fund is somewhat new with an even more recent manager.)

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Apr 2013

Model Stock Fund Portfolio

Our Specific
Fund Recommendations

Fund Category

 Recommended Category Weighting
(vs Last Qtr.)
-Fidelity Low Priced Stock (FLPSX)
 (See Note 1)


    12.5% (12.5%)

-Tweedy Brown Global Value
 (TBGVX) (C & M)
-Vanguard Internat. Growth
-Vanguard Pacific Index (VPACX)
 (A) (See Notes 2, 3 & 4)


    27.5 (27.5)

-Vanguard 500 Index (VFINX)
-Yacktman (YACKX)

   Large Blend 

    15 (17.5)

-Vanguard Growth  Index (VIGRX)
-Fidelity Contra  (FCNTX)
  Large Growth
    12.5 (12.5)

-Vanguard US Value


    17.5 (15)

 Financials ETF (VFH)


    10 (5)

-Third Avenue Real
 Estate Value Fund


      5 (5)


  1. Funds with (C) are recommended for Conservative investors; (M) Moderate; (A) Aggressive.
  2. FLPSX currently has a 35% international position; we think this should pay off as international stocks are more undervalued than US stocks. If you want a fund that avoids such exposure, substitute Vanguard Extended Mkt. Idx. (VEXMX).
  3. ETFs (exchange traded funds) of the same category can be substituted for any of the above 3 index funds; e.g. Vanguard MSCI Pacific ETF (VPL) can be substituted for VPACX.
  4. We favor TBGVX over VWIGX right now because TBGVX hedges currency exposure, eliminating loses due to the stronger trending dollar since mid-2011.

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Apr 2013

Model Bond Fund Portfolio Recommendations

The mainstay for many bond fund investors should still be with one form or another of the PIMCO Total Return Fund (PTTRX). For those not aware of the fact, PIMCO launched an ETF version of the fund (symbol BOND) a little over one year ago. Even with the same "top of the line" manager, Bill Gross, this ETF may not perform any way near identically to PTTRX. In fact, over the last 12 mos., BOND has returned approximately 11%, while PTTRX "only" about 8%.

Some have attributed the outperformance to the relatively small size of the ETF as compared to the fact that PTTRX is the largest mutual fund in the world, allowing Gross to focus on his best bond investments within the ETF. Whatever the reason, we think BOND will continue to do at least as well, if not better, than PTTRX, but obviously, there are no guarantees of continued outperformance since the two are essentially different funds with the same manager.

Note that we have lowered our specific fund allocations to inflation-protected (TIPS), munis, and long-term bonds of any sort. On the other hand, we have raised our allocations to PIMCO/Harbor Total Return (or the new PIMCO Total Return ETF) as well as to our specific international bond fund choice, PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX).

We highly recommend PFRAX. Just as with TBGVX (in our stock portfolio), PFRAX will not suffer from the fact that the US dollar looks likely to get stronger. If so, one will not lose out as non-hedged funds will when foreign investments are converted back to dollars in a rising dollar environment. The fund has returned about 10% over the last year, compared to less than 4% for the main bond benchmark (AGG) and even beating PTTRX at around 8%.

We have discussed in prior issues why we see limited gains for government bonds (which include TIPS). Additionally, taking the added risk of meager yield gains in longer maturity bonds would seem not worth it. Muni bonds remain a big question mark, with most funds having slowed considerably since last July.

Model Bond Fund Portfolio

Our Specific
Fund Recommendations
Fund Category Recommended Weighting Now (vs Last Qtr.)
-PIMCO Total Return Instit
 (PTTRX) or
-Harbor Bond Fund


    37.5% (35%)

-PIMCO Real Return
-Harbor Real Return


    10 (12.5)

-Vang. Intermed. Term
 Tax-Ex. (VWITX)
 (see Note 1)

    12.5 (15)

-Loomis Sayles Retail


    12.5 (15)

-Fidelity High Income
 (see Note 2)

  High Yield 

    15 (15)

-PIMCO Foreign Bond
 Hedged) Adm (PFRAX)
-T Rowe Price Emerging
 Markets Bond  (PREMX)


    12.5 (7.5)

Note 1.Select a fund, if available, that has your own state's bonds for double-tax exemption.
Note 2. Unfortunately, our prior recently recommended High Yield funds are closed to new investors.
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Apr 2013

(Do Record Highs Tempt You to Change Course?, continued from page 1)

and on the other hand, do the same during a bull market, not rueing the fact of possibly missing out on much larger gains. Investors thus able to "stay the course," may find little value in my Quarterly model portfolio overall allocations to stocks, bonds, and cash which recommend periodically changing your overall allocations to these basic investment categories.

But for those who do believe, as I do, that there are better and worse times to have significant amounts of money tied up in stocks, and that to some extent, these times can be successfully predicted in advance, it follows that periodically altering one's allocations can significantly help one to achieve their financial goals.

While no one set of recommendations can equally serve the needs of all investors, my overall allocations to stocks for three "types" of hypothetical investors, based on risk tolerance, can serve as guideposts. While I assume that the majority of investors likely consider themselves as "Moderate Risk" investors and therefore gear my main recommendations toward them, factors such as age, current financial situation, and even personality can dictate either a relatively small or large degree of divergence. Of course, only you, yourself, can determine how much risk you are willing to take.

Unfortunately, it is common that investors use the stock market itself as an indicator of how much risk they should take on. Thus, since we have recently been hitting record highs, some investors are now thinking they should increase their allocation to stocks. This implies they may have been previously under-allocated to stocks, and due to mere performance alone, are now more willing to bump up their allocation.

I suggest that the best strategy is to always have at least a moderate allegiance to your chosen investment preference, whether it be stocks or bonds. That way, you do not have to always be looking over your shoulder as to whether you should be significantly more in or, possibly, out of the market.

Initially, as the stock market goes higher after a significant pullback, one might seriously consider increasing their allocation. But, in the current situation, the market has already been going up for more than 4 years now. Thus, if you already had a moderate position in stocks, rather than considering increasing your allocation to stocks, you might actually consider decreasing it to preserve some profits and in recognition that stocks are now a more risky place to be than they were going back at least several years.

If you find yourself significantly under-allocated to stocks right now, should you therefore increase your allocation? I think it is always preferable to get yourself to what you now consider to be your proper allocation, but only if you are willing to essentially look past likely short-term disappointments and stick with this higher allocation for at least several years. In other words, your 'proper allocation' should not rest on what may happen, say, within the next year or so, but rather, what one expects to be the end result over at least several years.

To recap: One's best plan of action, it seems to me, is not to increase your allocation solely based on stocks' strong current performance. To the contrary, plan on doing most of your additions to your stock portfolio when the market has been struggling. Such a strategy might take many years to implement: Who knows when stocks will again fall significantly? On the other hand, it may make sense take some off the table as the market goes higher and higher.

Alternatively, if you already do have a significant position in stocks, you may choose to let your positions ride. But once you see perhaps a 5% correction, you may wish to protect yourself against a potentially bigger fall by reducing your position at that time. The last 5% correction in the S&P 500 was in early Nov. 2012, nearly 5 months ago. Although not likely, perhaps it might take an equally long time for the next one.


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