Pre-mature To Dance On The Gross Grave

    Being that Bill Gross and the PIMCO Total Return Fund (PTTDX) represent a large portion in two of my three models, I find the need to defend Mr. Gross and his fund’s 2011 YTD performance.  I find it hilarious that a defense needs to be made, but it seems society is eager to tear down anyone who has been successful in the past.

    A big deal has been made of the fact that Gross miscalculated (for a very short period of time) earlier this year by betting against a rally in U.S. Treasuries.  This admitted misstep has been well covered in the financial media and has left the PIMCO Total Return Fund trailing many of its peers YTD.  Or has it?  Who exactly is a total return bond manager’s competition?  While the headlines are fun to read, they show a complete misunderstanding of the total return approach to investing in bonds.

    The main problem I see with managers within the total return bond sector is that they are automatically lumped in with other funds based upon their current portfolio weighting. Yes many of these funds, based upon their current positions, could be viewed as short-term government securities funds, but in reality they offer so much more with a tremendous amount of flexibility.

    A total return investing approach to bonds means that the management team is focused on the overall performance of a bond.  This means both the price and the yield of the bond are factored into total performance measures.  Unlike corporate bond, municipal bond and U.S. Treasury bond funds that have to invest specifically within those sectors, a total return bond manager is not handcuffed by these restrictions.  Good total return bond managers will try to position their portfolios in bond securities that they feel offer the potential for the highest total return on investment.

    Do you think a high quality corporate bond fund manager was happy that he or she had to own corporate bonds in 2008?  I’m sure they saw risk all over the bond horizon but there was not much they could do about it because they were mandated to own corporate bonds.  In 2008, the average corporate bond fund lost 15% of its total value, and the average municipal bond fund lost 10%.  In that same year Gross guided the PIMCO Total Return Fund to a gain of 4.48%.  The total return approach gave Gross the flexibility to avoid areas of the bond market that others could not.  Again, not all of the others are bad managers, but they simply had to stay within their sectors.  I have a large amount of respect for the management team of the Loomis Sayles Bond Fund.  The fund was down almost 22% in 2008.  Not beause the managers stunk but because there was not much they could do when the sector they invest in was out of favor.

    Sometimes the best offense is simply a good defense and that is why I prefer the total return approach to owning bonds within a strategy that deploys tactical allocation.  I want a manager that can focus on total return and capital preservation, and has the ability to sit on a tremendous amount of cash.  Not being mandated to invest a minimum percentage of your portfolio in a specific sector (ex. corporate bonds) gives these managers that ability.

    While everyone is eager to compare the PIMCO Total Return Fund to government securities funds let’s remember that is not accurate.  How did Gross achieve such outperformance in the last decade?  It certainly did not come from owning treasuries.  In fact, if we could look back 11 years ago at the fund it would most likely resemble a corporate bond fund.  As the Fed raised rates aggressively in 2000 to cool down the economy, Gross began buying a tremendous amount of high-grade corporate bonds.  As it turned out the Fed overshot and rates have been coming down ever since.  That decision provided a large amount of appreciation for the fund.  While Gross was able to lock in these gains and go to cash, corporate bond fund managers watched their portfolio values rise and then comeback down because of their mandates.

    My theory is that when someone has earned the title “Bond King”, and did not have it handed to them, then I would like that person to manage my bond assets.  So before you decide to dance on Gross’ early grave, ask yourself why it makes you feel good to do so.  We are talking about a mutual fund and a manager that is still up 3.14% YTD.  If you are living in a “what have you done for me lately” world then you need to take the blinders off.  Bill Gross’ risk vs. reward returns over the last 3, 5 and 10 years are still unmatched.

    Go ahead and bet against the “Bond King”, but if you do, I would suggest getting some pretty favorable odds.  It is a bet that I am smart enough not to make because I understand what I own and why I own it.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

Strategic Ideas For Small Investment Dollars

    Often, investors will look at the allocation strategies I deploy and quickly realize that they cannot do the same.  The reason is they do not have enough investment dollars to cover all of the necessary asset classes that I have declared essential.  This frustrates me because I believe it encourages improper investing, and discourages many younger investors right out of the markets.

    There are still ways to have your dollars managed in a manner that focuses on strategic allocation at an affordable cost.  Notice I said “strategic” allocation.  Heck the reason I am blogging about this topic is that most asset allocation mutual funds (also called balanced funds) are crap. 

    The majority of the balanced funds I have researched seem to have no interest in the Sharpe ratio.  They seem to be focused on driving down beta (volatility) with what seems no ability to squeeze out alpha.  At some point you need to produce some upside.  Take a look at the Vanguard Balanced Index Fund (VBINX) as an example.  Since the beginning of 2000 and as of the close on December 16, 2011 the fund is up +50.02%.  Now compare that to a strategic asset allocation strategy like my 50/50 model.  That model is up 182% is the same period of time and achieved this return with a much lower beta than the Vanguard fund.  So in my research that is what we needed to focus on.  Not just mutual funds that will allow smaller investment dollars but funds that deploy tactical asset allocation and that seem to truly understand the Sharpe ratio.

    My research yielded two very impressive choices for smaller investment dollars.  The first mutual fund I came across is the Permanent Portfolio Fund (PRPFX).  This is an excellent example of tactical asset allocation.  The manager, Michael Cuggino, simply gets it and has been able to squeeze out tremendous returns while reducing volatility.  The fund is extremely affordable with no sales charges or 12-b-1 fee’s, and boasts a very low expense ratio vs. its peers.  The minimum investment is either $2500 or $1000 depending upon the type of account you are opening.

    The second mutual fund, I have been familiar with for years and it is the BlackRock Global Allocation Fund A (MDLOX).  Again, this manager understands his job.  The returns, though lagging my models, have been supherb.  This mutual fund is a perfect example of knowing what you get when you buy it.  The fund manager, Dennis Stattman, has been managing the fund since 1989.  That is important to know because it tells us that the historical returns we are viewing were achieved by the manager still managing the mutual fund.  (Make a mental note: Make sure the historical returns that impress you were achieved by the current manager of the fund.  The returns are meaningless if the manager who achieved them is no longer managing the fund.)

    The one downside with this mutual fund for smaller investors is the fact that there is a sales charge and 12-b-1 fees, and these are not avoidable.

    These are 2 very rare examples of strategic allocation within one mutual fund at its finest.  Again, I feel most of the “balanced” mutual funds are garbage.  Any idiot can throw a mix of assets together and call themselves balanced.  The real trick is to figure out how to capture much of the markets upside with little of the markets downside.  Sadly, most of these overpaid professional “balanced” fund managers just do not understand how this is achieved.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

In January, It's All About Health Care

Looking back over the last 25 years it is clear that the health care sector has been the best performing sector in the month of January.  I do not know if this outperformance is correlated with New Year's resolutions to better our health, but I do know the performance is obvious and very correlated to both the DJIA and the S&P 500 Index.

Let's take a look at the returns of the average health care mutual fund versus both the DJIA and the S&P 500 over the last 25 January's.

Year	Avg. Healthcare Fund	DJIA	S&P 500
1987	12.28%	13.82%	13.47%
1988	6.26%	1.09%	4.21%
1989	6.69%	8.28%	7.32%
1990	-6.15%	-5.72%	-6.71%
1991	8.00%	4.08%	4.36%
1992	1.64%	1.83%	-1.86%
1993	-2.99%	0.33%	0.84%
1994	5.96%	6.06%	3.40%
1995	3.66%	0.33%	2.59%
1996	4.95%	5.51%	3.40%
1997	5.37%	5.70%	6.25%
1998	2.43%	0.01%	1.10%
1999	1.14%	1.97%	4.18%
2000	9.82%	-4.80%	-5.02%
2001	-7.24%	1.02%	3.55%
2002	-6.19%	-0.90%	-1.45%
2003	-0.08%	-3.32%	-2.62%
2004	4.19%	0.45%	1.83%
2005	-3.76%	-2.59%	-2.43%
2006	2.90%	1.50%	2.65%
2007	3.04%	1.40%	1.51%
2008	-5.01%	-4.48%	-5.99%
2009	-0.85%	-8.65%	-8.43%
2010	0.35%	-3.32%	-3.59%
2011	1.45%	2.85%	2.37%

As you can see the performance for the month of January over the past 25 years has been strong for both the average health care mutual fund and the domestic stock markets.  Both the DJIA and the average health care fund have posted positive returns in 17 of the past 25 January's.  While the S&P 500 has posted positive returns in 16 of the past 25 January's.

With the markets overall performance so strong in the month of January it should be noted that most sectors have faired pretty well, but not nearly as well as the average health care mutual fund.  Though January has been fairly good to most sectors and the overall market the past 25 years, my research did yield interesting weakness in the average performance of equity energy mutual funds.  Over the past 25 January's the average energy equity fund has only posted positive returns 11 times.  In fact,  in a stretch of January's from 1998 to 2003 the average equity energy fund posted negative returns every single Janaury.  I do not believe the data is strong enough to suggest a short, but it should at least encourage one to pause before building a new position in a broad-based energy equity portfolio prior to the new year beginning.

If you feel the overall market is the place you want to be in the month of January, then it may be wise to consider a position in health care.  The Vanguard Health Care ETF (VHT) is an excellent choice to gain this exposure, and has done a fairly good job simulating the performance of the very well-managed Vanguard Health Care managed mutual fund.

Good luck everyone!

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

New Year’s Resolutions For The Average Investor

    It’s that time of year again when individual investors are eager to wipe the slate clean and so-called experts make predictions sure to go wrong.  The slate should not be swept clean but rather used to learn from year-to-year.  Many individual investors have yet to learn from mistakes of the past and this has led to lackluster performance.

    Use the common mistakes of the past to build your New Year’s resolution for today.  Not just a resolution for the coming year but a sound resolution that can be repeated every year.  Based on my observance of the average individual investor I have come up with a few resolutions of my own and I feel all investors could benefit from following.  They are as follows:

I will try to reduce or eliminate “emotions” from my investment process

    I believe all individual investors are emotional.  The best long-term investors simply do a better job of managing their emotions.  For some reason, individual investors (the ones that are the most emotional) get very angry when it is suggested that they are too emotional when it comes to their investments.  Unfortunately, most of the time it is true and this is the single most destructive type of investing.

    The data support’s the emotional investing theory.  Consider the following data from the Investment Company Institute (ICI):

-        In 1999, $505 billion flowed into mutual funds.  The market then went on a three year slide. 

-        In 2002, $27 billon was taken out of stock mutual funds.  On March 11, 2003 the market began a 4 ½ year bull run. 

-        In December of 2008, $20 billion was cashed in and taken out of stock mutual funds.  The S&P 500 index now sits nearly 46% higher than its close at the end of 2008.

-        In March of 2009, $25.5 billion was once again taken out of stock mutual funds.  The S&P 500 index is up almost 64% from its March 2011 close.

    It is time to eliminate the emotional element from our investment process.  It is also the time to stop relying on those that sell investment products based upon the emotion’s that we exhibit.  Only good things can come from this self-examination and making the appropriate changes.

I will only invest in products and strategies that make sense to me

    Not every strategy you hear about is meant for your ears.  I love CNBC, and I enjoy the excitement that traders come onto air with throughout the day.  However, just because I love their enthusiasm does not mean that their suggestions are right for me.  I’ll be honest with you.  When traders make suggestions throughout the day telling viewers what they are buying and selling, what currencies they are trading and discussing options contracts, it is all Greek to me.  So, if it is Greek to me then would it make sense to invest my money based on their suggestions?  No.  My models have been very successful over the years, and they make sense to me.  That is why I created them.  Investing in a manner that you are comfortable with and that makes sense to you is something nobody can dispute.

Start understanding what you own, why you own it, and what it is designed to do for you.

I will not chase returns

    This may sound like an obvious resolution to make, but believe me, when “emotions” are involved most individual investors follow the herd into the hot investment of the day.  For 2 years, every single day I have seen a commercial on television with some investment group pimping gold.  I certainly agree that gold and precious metals should be a part of any well-designed portfolio but at a comfortable weighting.  Did we learn nothing from past market booms within specific sectors?  I seem to remember the same type of investment attitude with technology stocks, internet IPO’s and real estate.

    Chasing returns is the most common mistake made by investors inside of their work-related retirement accounts.  The first thing investors do each year is look at the list of mutual funds available and scroll down until they find the best performing fund from the previous year.  Then, many investors move all of their money into that mutual fund.  And we wonder why individual investors are a decade behind where they need to be.  I don’t know about you but I would much prefer a diversified approach.  A diversified approach would probably lead to reducing your allocation in that top performing fund.

Stop chasing returns.

I will educate myself a little each day

    Knowledge is power.  There is an entire financial services industry that loves the fact that most individual investors have done nothing to educate themselves.  This leads to our reliance on them and the products they sell.  If you take the time to educate yourself then you will quickly realize that investing is not “rocket science”.

    Investors have invested time and money for their education.  They have obtained doctorates, masters, bachelors and associate degrees, or some type of technical training.  Why?  I believe to have a career and hopefully live a comfortable life.  However, we have not done enough to educate ourselves on what to do with the savings we have accumulated.

    I do not like to be spoon fed, and I want to know what is in the kool-aid before I have a sip.  Sticking to the basics of diversification and asset allocation would have served you quite well.  However, if you are waiting for someone in the media to tell you about the basics then you will be waiting a long time. 

    Asset allocation is boring.  It doesn’t sell well.  Do you really want to look back someday and discover the wildest ride of your life occurred with your life savings?  I sure don’t.  It is a ride the average investor does not understand and cannot afford to take.

    Take the time to feed your brain a little each day.  The internet is full of wonderful resources that will help you understand the world of investing.

    I have stuck to these resolutions for over a decade and they have served me well.  They may not apply to you, but I have a feeling that many individual investors can benefit from this type of self-examination.

Happy New Year!  Good luck everyone.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”