Master Achievement

In managing my investment accounts, I have spent a considerable amount of time evaluating various strategies.  What I have come to appreciate in managing my 401 account is what I call the Fund of Funds Portfolio.  This is an easy to manage system that will get you into the best performing assets at the right time as well as time the market of your investments.

 

The secret to portfolio management is diversification.  Modern portfolio theory has proven that diversification increases returns on a risk-adjusted basis.  Jim Cramer speaks highly about being diversified with your portfolio holdings on his show Mad Money and his investing books.  The Fund of Funds Portfolio has 12 different asset classes across major investing categories from domestic stocks to private equity (see table).

 

The asset classes are listed in the following table as an ETF fund.  As you can see, these assets include: stocks, bonds, commodities, real estate, currency, and private equity.  The classes have both U.S. and foreign investments in stocks and real estate.  also, stock funds have both large cap and small cap funds.  Foreign stock funds have developed and emerging markets.  The only asset class missing is a hedge fund which is problematic to identify in the ETF universe.  It is OK to substitute other fund families such as Fidelity for Vanguard, etc. depending on what funds you have access to in your account.

 

 

Diversification is a risk reduction strategy but you can increase your returns if you are in the right asset categories at the right time.  For example, why would you want to be in bonds when interest rates are 1%?  In this example, your return is lower than the inflation rate of 3% so you are losing purchasing power.  The Fund of Funds Portfolio has a ranking process to identify what and when to be invested.  And when the market hits a period like September 2008, you should not be invested in stocks at all.

 

Rules of the FOF Portfolio:

 

 

 

The table above indicates the top 5 funds as emerging markets (VWO), real estate (VNQ), small caps (VN), developed markets (VEU) and private equity (PSP).  The average returns run from 20% to 37%.

 

This is a simple theory of being invested in the top 5 asset classes at all time.  Why 5 funds?  Because back testing has indicated that you get a better return with 5 Funds in the portfolio.  Also, this keeps you out of the less desirable funds that have not performed well in the market.

 

What type of perfromance should you expect?  when backtested, this system had an annualized return of around 13-15% from 1985 to 2008 (with different ranges for private equity).  The standard 60% stocks and 40% bonds had a return of 11.4% during this period.  Generally, assets are going up 70% of the time and declining 30% of the time.  But not all asset classes and uptrending or downtrending at the same time.  This is were you get a little extra return in this model by being in top perfroming assets. 

More information can be found in “The Ivy Portfolio” by Mebane Faber and Eric Richardson who discuss variations of the portfolio and the backtesting results.  This book discusses how to track and mimic the investment strategies of the highly successful Harvard and Yale endowments.

 

The success will depend on how disciplined the investor is regarding following the rules.  This eliminates emotions and rash judgments that can adversely affect your performance.  My analysis indicates that returns are lower and volitility higher when prices are below the 100-day average.  This is part of the rationale behind why the FOF timing model works as it keeps you out of high volotilitiy funds.

I will share my monthly updates of what ETFs to be invested in for this portfolio.