2016 Tom Madell, Ph.D.

May 2016

Email: funds-newsletter@att.net

Mutual Fund/ETF Research Newsletter


Free Newsletter (Always)
Strong Results Since 1999!

To Our Subscribers and Other Readers:

It's hard for me to believe that I have been writing and publishing this Newsletter for nearly 17 years now.

I started in the Spring of 1999. At the time, I was working as a technical writer for Hewlett-Packard in the heart of Silicon Valley. But I planned to retire early. So, I figured I needed to ensure that when I did, I would have a project big enough to keep me occupied so I wouldn't get bored. I chose to try to publish a newsletter, something that combined one of my biggest interests, investing, with what I had always done throughout my life - research and writing.

I thought it highly improbable that I, without any degree in business or economics but rather, psychology, nor any knowledge of marketing, could reach more than a small handful of co-workers, relatives, or maybe a few others.

However, I completely underestimated the reach of the Internet, which was still pretty new at the time. A considerable effort in those early years to learn the workings of search engines was able to get me to high page rankings and probably made all the difference in eventually attracting the thousands of people who read my articles today.

Writing my Newsletters is still my main activity today, along with managing my own investments. Learning about investing and trying to help others with theirs has probably been the most significant thing I have accomplished throughout my prior careers as a psychologist and a computer professional in spite of the fact that I haven't ever received any compensation for doing it. And, in many ways, it has been more interesting.

(continued page 3)


-These Funds Are Now Poised to Outperform
  (begins below)

-Model Portfolio Performance (see page 4)   

These Funds Are Now Poised to Outperform

By Tom Madell

For several years now, I have been recommending that investors put a somewhat higher emphasis on two categories of stock funds/ETFs, namely Large Value and International, along with a lower emphasis on domestic Large Growth and Small-/Mid-Cap. The reason is straightforward to me although less than obvious for most: While the former two categories have consistently trailed US broad stock benchmarks over the last several years, the latter two have at times exceeded them.

In the sometimes upside down world of investing, there is a tendency, usually after a considerable number of years, for underperforming and relatively weak performing categories to switch places with the well-performing ones.

Finally, after some trepidation that the approach was not working as expected, except in the case of Small-Cap funds which have indeed gone from being stellar performers to among the weakest over at least the last year, it now appears that the strategy may be beginning to pay off. However, it has been a frustratingly long wait, although an interval of one or two years for such an expected turnaround should not be regarded as particularly unusual.

Large Value

I believe the long expected rotation to value stocks may now be underway. So far this year, all three value stock category averages, Large, Mid-Cap, and Small, are running well ahead of their three growth stock brethren categories. The average Large Cap Value fund is outperforming the average Large Cap Growth fund by over 4%. While such a short spurt may

(continued on page 2 below)

Page 2

May 2016

(These Funds Are Now Poised to Outperform, continued from page 1)

not in itself seem significant, on a quarterly basis one has to go back consecutive 29 quarters, to the third quarter of 2008, to see an outperformance by Large Value over Large Growth that is that large. Note: Performance figures cited are through Apr. 20 unless otherwise noted.

If Large Cap Value funds continue to outperform Large Cap Growth at the same pace for the rest of the year, there would be a huge 12% spread by year's end. While such a large disparity might seem highly unlikely, it cannot be totally dismissed.

If you compare the performance of two Vanguard index funds, Vanguard Index Value (VIVAX) and Vanguard Index Growth (VIGRX) as proxies for each of these categories, you will see that over the last 9 years, going back to May 1, 2007, Value has gone from a net asset value (NAV) of 27.85 to only 33.03 for a cumulative gain of 18.6% (not annualized, excluding dividends). Growth, on the other hand, has gone from a NAV of 31.44 to 55.64 for a gain of 77.0%. The difference is a whopping 58.4%. When averaged out over the 9 years, VIGRX has exceeded VIVAX by about 6.5% per year.

Since Large Value has been so far behind, merely gaining back one year of this outperformance for the rest of this year would bring it close to an 11% outperformance of Large Growth. However, it seems far more likely that the category will see smaller outperformances over quite a few of a number of upcoming years to enable it to eventually catch up to Large Growth. I, for one, believe such an equalization is reasonable to expect. In fact, history shows that value stocks tend to be better long-term performers than growth stocks, supporting the potential for a big upcoming turnaround.

What else might argue for my suggested Large Value overweighting? Evidence suggests that as the Fed raises interest rates which they already have begun to do, value stocks tend to get stronger. (For a further discussion of this, see the following article.) Further, with growth stocks having reached a greater degree of overvaluation in the recent past than value stocks (although each category is more fairly valued now), Large Growth stocks would seem more likely to suffer if and when investors become unnerved and decide that they need to protect their profits.

International Stocks

Even more severe than the long-term underperformance of value stocks has been that of International funds/ETFs. When one compares the performance of the average International category fund with that of the S&P 500 index over the last 10 years (thru Mar. 31), one finds an annualized total return for the foreign category of 1.8% vs 7.0% for the US-only index. Emerging Market funds have done only slightly better at 2.5%.

Is there any sign of a possible turnaround here? While only tentative given the short time period, a proxy for the entire International category, the Vanguard Total International Stock Index Fund (VGTSX), has gone from a NAV of 12.87 on 01/20/2016 to 14.98 on 4/20 for a 16.4% gain over 3 mos. Looking back over its quarterly returns, one has to go back to the 3rd quarter of 2010 (21 consecutive quarters ending this past Dec.) to find a gain that big.

The same can be said for emerging markets. Looking at the Vanguard Emerging Mkts. Index Fund (VEIEX), the NAV has gone from 18.06 on 01/21/2016 to 22.38 on 4/20 for a gain of 23.9%. To find a closely comparable quarterly gain, one would need to go back to the 3rd quarter of 2009 (25 consecutive quarters, ending this past Dec.).

For both Large Value and International stocks, while not proof that a longer-term turnaround will be forthcoming, the data seem to be possibly suggesting that these categories of funds/ETFs will be better places to emphasize within a diversified portfolio over the next few years. With International stocks, and especially emerging markets relatively undervalued, these categories of funds/ETFs would appear more appealing than US-only stock funds when looking at annualized return potentials over at least the next several years.

Still, there can be many "false dawns" where a category seems to be making a comeback but, not much later, falls back again. And, even if the outperformances I expect occur, it may not mean excellent absolute returns but only relatively better returns than the aforementioned competing categories. But especially when viewed over the longer term, an approach that incorporates the notion of comebacks by underperforming categories often seems to be an effective strategy when deciding which funds to emphasize within portfolio whenever considering periodic changes.

But turnarounds don't just happen because one "thinks" they should happen. The necessary ingredient is typically that the category in question has either become under-/overvalued, or, a major and usually unexpected development occurs within the markets that creates a nearly totally new mindset in investors, or both. While the second of these conditions is almost impossible to predict and is relatively rare, the first can be recognized by investors who are willing to pay close attention to relatively extreme over- or under-performance within the category averages. [End]

Page 3

May 2016

(To Our Subscribers and Other Readers, continued from page 1)

However, I have yearned to do something that goes beyond my Newsletter. The way I look at it, a newsletter is a great way to tap into the ongoing flow of investing ideas and strategies. The investing world is ever-changing, and for those who care to follow the changes, there can be considerable financial rewards, not to mention a constant source of renewed interest.

A book about investing, on the other hand, would offer the opportunity to get away from the month-to-month churn of the markets and instead focus on the essential, more enduring aspects of successful investing. While there are a myriad of investing books that already do this, it appears to me that, as reflected in the popularity of my Newsletters, there is still the need for a research and experience-based set of recommendations and ideas that have proven to work in the past but are pretty simple to understand and to implement.

A number of years ago, I was in contact with publishers and book agents trying to "sell them" on the specifics of such a book about fund investing. The key words, however, were indeed "sell them," as getting a book traditionally published seemed to me like 90%+ marketing; at best, only 10% had to do with my actual writing and research about investing. Now, though, anyone with the desire, can write a book and self-publish it, avoiding the constant "but how many copies will it sell" mentality, which is unfortunately an almost impossible roadblock when dealing with the mainstream publishing world, unless of course, one is a near-celebrity.

When I last attempted to do a book, I worked on both the book and the Newsletter simultaneously. However, this is no longer feasible for me and, at best, would take me years to ever finish such a book. Therefore, I need to figure out a different approach to succeed.

So, here is the solution I've arrived at: Since I do not want to stop writing my monthly Newsletters (or nearly every month since I am not always available every month), I plan to temporarily, for perhaps the next 6 to 12 months while putting a book together, implement the following change:

Rather than researching and writing Newsletters that at times contain more than one article and together average about 6 or more pages, I will spend roughly an equal amount of time doing the book as I am doing the Newsletter. This will likely mean somewhat shorter Newsletters in the months ahead.

Please note that the purpose of doing a book is as stated above: To provide a more basic overview of long-term investing. It is not for the purpose of trying to profit from the sale of such a book. My philosophy of publishing remains the same - to help others with investing, which also winds up helping me.

Other thoughts: For me, when publishing my online Newsletter, it almost seems there is no "end product," just an electronic link to some words on a computer screen. Once I complete my book, however, something tangible will exist. It will contain a more comprehensive set of ideas which will be readily accessible and easily referred back to whenever content on a specifically covered topic is wanted.

You can be assured there will be no marketing effort made aiming to try to get current readers to acquire the book, other than to mention that it is available and to summarize what it will offer. The book will most likely be available online at either a trivial cost to cover any printing expense, or even for free, if only an online version such as in the format for my Newsletters, is desired.

Another reason for the book: It is even possible that if some readers don't feel they have been able to get what they want lately by reading the monthly Newsletters, that the book will be more matched with their needs and interests.

Feedback on any aspect of the above is welcome, and especially, any ideas you may have for desired content that might be valuable to a range of readers of such a book. As I foresee it, the book will be targeted not as a introduction to fund/ETF investing, but for readers who already know the basics but aspire to make the most from their investing efforts.

Best wishes,

Tom Madell, Publisher

Page 4

May 2016

Model Portfolio Performance

At the end of each calendar quarter, I regularly discuss how investments recommended 1, 3, and 5 years ago would have done if held up to the present. The analysis is intended a) to hopefully impart confidence to readers in this Newsletter's specific fund recommendations when held over significant periods based on subsequent results, and b) can show the benefit of over-/under-weighting of fund categories to achieve index-beating portfolio performance. The alternative, of course, is merely to always divide portfolio investments according to a static allocation, such as, for example, would be the case with an always equal percent commitment to different categories such as growth and value funds, or merely investing in index funds that aim to match the market.

For many years, I have maintained that while it is extremely difficult, if not outright impossible, to anticipate which categories of funds will do best on a relatively short-term basis (that is over one or even two year periods), over longer periods, it does become possible, although still admittedly difficult. If so, this provides an opportunity to do better than using a static allocation. With this in mind, let's look at how these somewhat recent recommendations have done.

First, consider my recommendations from one year ago. (Note: Readers who wish to more fully explore my prior recommendations can review them in more detail by clicking on each link shown.)

To evaluate the effectiveness of my stock portfolio, I use a blended benchmark made up of 3 Vanguard index funds in the proportions shown: US stocks (65%), and both International (30%) and emerging market (5%) stocks. If you prefer, you can instead compare my results with the return on Vanguard Total World Stock Index (VTWSX) which includes the same components in close to the same proportions as my three fund benchmark.

Stocks performed pretty poorly over the 12 mos. ending 3/31/16. The three fund benchmark returned -3.3%, while VTWSX returned -4.2%.

My Model Stock Portfolio returned -3.4%, a hair worse than my own benchmark, but better than VTWSX. We were helped by our large emphasis on large cap US stocks since small- and mid-cap US stocks did more poorly, as I had expected.

My portfolio, like the benchmarks, was dragged down by International stocks, but helped by a relatively smaller allocation to them than either benchmark. We were helped by all (but one) of our selections of specific US funds, which beat their category averages. However, we would have done better if we had not overemphasized Large Value stocks at the expense of Large Growth stocks.

Regarding our Model Bond Portfolio, for which we use Barclays Aggregate Bond Index as a benchmark, we trailed its return of 2%; my portfolio returned 0.9%. (This benchmark is not available as a specific fund but can be closely tracked by investing in iShares Core U.S. Aggregate Bond ETF (AGG) which returned 1.9%.) Most of our choices lagged the benchmark, and several even showed negative returns. However, this jibes with the fact that the average reported return of all taxable bond funds was actually negative at -1.3%. Our biggest shortfall was big allocations to PIMCO Total Return Fund and its companion ETF. Our best recommendation was our investment in municipal bonds.

Here's how our recommendations from 3 years ago did.

Our static comparison benchmark returned 7.7%, while investing just in the Vanguard Total World Index would have netted 5.7%. By contrast, my Model Stock Portfolio returned 7.8%. (All results are annualized.)

Once again, my relatively low allocation to International stocks, as well as no allocation to Emerging Market funds, helped, as these categories were poor performers compared to US stocks. Aside from that, most of our other choices performed pretty consistent with their category averages. Our Large Value fund, which we again had a relatively high allocation to and which beat its category average, did not help the portfolio as much as if a greater allocation was made instead to our category-beating choices of Large Growth funds.

How did our bond recommendations from 3 years ago do? Our bond benchmark returned 2.5%, but the average reported return of all taxable bond funds netted only 0.7%. Within this context, our portfolio return of 1.5% was a little disappointing but within the right ballpark. Most of our fund choices lagged the benchmark, although our muni bonds and international bonds did well.

Now let's see what we recommended 5 years ago where we outperformed the benchmarks in every case.

Our Model Stock Portfolio returned 8.0% annualized. This compared to a 7.6% return for our benchmark and 5.4% for VTWSX.

Page 5

May 2016

In this case, we correctly foresaw Large Growth funds as a better place to be than any other basic fund category which added to our performance. Likewise, our allocation to International funds was much lower than that of our benchmarks; since the average reported return to International funds was only 1.8%, a low allocation allowed our portfolio to profit from the much higher returns on US stocks. Regarding Small- and Mid-Cap funds, my above average allocation, at that time, of 35% further enhanced my portfolio return. All told, all 11 out of 11 of our US stock fund choices beat the return of the average of all US diversified stock funds which came in at 7.6%.

Our Model Bond Portfolio from April 2011 also edged out our benchmark, returning 3.9% annualized vs. 3.8%; the average reported return for all taxable diversified bond funds was even lower at 2.7%. Our main advantage came from high yield bonds; a somewhat high allocation to Inflation bonds detracted.

In summary, while the returns of mutual fund/ETF categories will vacillate, there is, generally speaking, the possibility of anticipating in advance which categories will do better than others and using these projections to help improve overall portfolios performance. I tend to use a proprietary formula I developed for making these judgments.


If not currently a subscriber and wish to sign up to receive notification of new Newsletter postings as well as infrequent, but crucial, investment Alerts, click here.


If you find this month's Newsletter helpful, consider pasting this link to it in an email to a friend: