MUTUAL FUND TRENDS & RESEARCH NEWSLETTER http://funds-newsletter.com email: tom@funds-newsletter.com Investment Newsletter #27 (July 3, 2000) Tom Madell. Copyright 2000 Changes to Recommended Allocations and to Our Model Portfolio Our model portfolio, presented in the 12-31-99 issue and adjusted just slightly in the Apr. 1, 2000 issue, is now UP 2.4% year-to-date. This is 3.4% ahead of the S&P 500 and 5.0% ahead of the Nasdaq Composite, both of which were in negative territory to end the 2nd quarter. Given the volatility exhibited by the financial markets so far this year, to be in positive territory even by just a few percentage points doesn't seem too bad an outcome. We think that our mild cautiousness in many of the newsletters earlier this year turned out to be quite justified and we continue to feel that returns will not be quite up to par for the remainder of the year ahead. With that in mind, we are suggesting some further mild changes in how someone with a diversified portfolio might try to maximize their results in the upcoming months. If your portfolio is not all that diversified, you might, as usual, want to check out some of the various different investment areas/funds we include. Note: Suggestions were finalized on July 2, 2000 before the first trading date of the 3rd quarter. Overall Allocation ------------------------------------------------------ Current Previous Stocks 55% 60% Bonds 25 25 "Other" 20 15 ------------------------------------------------------ As you can see, we have reduced our allocation to traditional stock funds slightly, and likewise increased the allocation to "other" types of funds. Actually, this may not represent any less allocation to stocks per say because under "other", I also include funds that may be stocks but which fairly different from the mainstream type of fund, such as real estate funds or natural resource funds. I include these types of funds under "other" mainly to emphasize that someone might want to own investments in a category that is not highly dependent on the overall performance of the stock market to still do well. Our allocation to bonds remains unchanged even though there are some reasons to be somewhat positive about the outlook for bonds during the remainder of the year. Our 25% allocation to bonds so far this year has improved the overall performance of our model portfolio. In fact, so far this year, our bond results, up 3.5%, are ahead of our traditional stock fund results which are up only slightly (0.1%). So, even though bonds have the potential of outperforming stocks for short periods, we don't think their current prospects are that compelling that we would urge people to commit big percentages of their investments to them now, and most likely, well into the future. The reason we have raised our allocation to the "other" category is that we are now recommending that you put up to 10% of your investments into the REIT category. For the last 6 mos., the median REIT return fund was 14.2%. Our previous recommendation that you put around 5% of your investments into this category of fund along with some of our specific bond fund suggestions, were the biggest bright spots within our overall model portfolio. We think that REITs are still very attractive and therefore could easily outperform other investments in the stock and bond category. Another reason for considering a higher allocation to "other" is that with short-term money market interest rates offering returns of well over 6% and possibly headed higher, you may be able to get a "decent" return while awaiting better possibilities to arise down the road in the bond and stock markets. Stock Fund Categories Here is a rough breakdown of how we currently recommend you divide up your fund investments: ------------------------------------------------------ Current Previous Large Cap (US) 45% 40 Small/Mid Cap (US) 20 20 International 35 40 ------------------------------------------------------ We are somewhat more positive on large cap stocks now that a large majority of such stocks are reasonably priced. And we think large stocks won't be hurt as much as the other categories in any downward action. With regard to growth vs. value choices, once again, many US value funds with perhaps the exception of small- cap value funds, wound up disappointingly after some promising spurts during the last quarter. We are recommending considering reducing one's position in the US large-cap value area, while maintaining all other value positions. If the value underperformance continues for another quarter or two, it might be well to change our recommendations in the future more toward emphasizing the best blended funds in their place. We have been disappointed along with many other patient (but not to the point of forever) investors. We are still quite postive on international stocks long- term. However, given the large returns that many of these stocks showed last year, many still appear to be experiencing a mild rest so far this year. And, as I pointed out recently, most of such returns to U.S. investors continued to be hurt because of the strong dollar. There are signs that the dollar will weaken in the period ahead but this is offset somewhat by the fact that interest rates appear headed higher in many major countries throughout the world. With these trends in mind, the following table shows how we are positioning our model portfolio for the months ahead. Don't forget that this portfolio is somewhat idealized - hardly anyone will have an identical portfolio, but it gives you an idea of some suggested proportions for your own investments even though you may want to own only a subset of such funds, or their equivalents. Our model portfolio also serves as a checkpoint for people who want to see if a systematic strategy based on economic trends, such as we recommend, will turn out in hindsight to be justified. So far, as I presented and provided data about in my last newsletter, we feel that it is. Stock Funds -------------------------------------------------------- Suggested Yr-to- Fund Morningstar Allo- Date Style cation; Return; last 3-31 to Qtr's. 6-30-00 Alloc. Return in ( ) in ( ) -------------------------------------------------------- Vanguard Foreign International (Large 15%(15%) 2.6% Growth Blend) (-3.2%) American Century Foreign 5 (5) -4.9% International (Large Growth) (-9.0) Growth Vanguard Index Foreign 10 (10) -5.8 Pacific (Large Value) (-5.7) Vanguard Index Foreign 5 (5) -2.6 Europe (Large Growth) (-2.7) Janus Overseas Foreign (Large 0 (5) 1.5 (Note: Fund closed Growth) (-11.4) to new investors; if Fund re-opens we will reconsider) Janus Fund Large Growth 15 (10) 3.0 (-6.7) Vanguard Index 500 Large Blend 15 (10) 0.4 (-2.6) Vanguard Growth Large Value 10 (10) -2.0 and Income (-2.9) Vanguard Windsor Large Value 10 (5) -0.9 (-0.5) Vanguard Small Cap Small Cap Blend 5 (5) 3.6 Index (-3.0) Vanguard Extended Mid Cap Blend 5 (5) 0.2 Market Index (-8.7) T. Rowe Price Mid Cap Value 5 (5) -0.8 Value (-1.2) Fidelity Low Small Cap Value 5 (5) 5.4 Priced Stock (0.9) Note: The benchmarks for the 3-31-00 to 6-30-00 returns are: S&P 500: -2.9% Nasdaq: -13.3% Bonds Fund Categories For those who are or might be interested in bond fund investments, as we state above, we think that bonds will continue to do pretty well in the months ahead. As a result, we are recommending a somewhat higher weighting for longer-term bonds than before. We also feel that short-term bonds will not perform particularly well at this point although, in truth, we have never been big fans of short-term bonds except for very conservative investors. Our reasoning is that if the Fed raises interest rates any further, this will probably hurt short-term bonds while it may help longer-term bonds somewhat in that it shows Fed "resolve" in fighting inflation. Here is a summary of our overall suggestion as to how far to go out in your bond fund maturities, followed by our model portfolio suggestions and percentages: ---------------------------------------------------- Current Previous Long Term 50% 40 Intermediate 50 50 Short Term 0 10 ---------------------------------------------------- Bond Funds --------------------------------------------------------- Suggested Year-to Fund Morningstar Allo- Date "Interest cation; Return; Rate last 3-31 to Sensitivity" Qtr.'s 6-30-00 Alloc. Return in ( ) in ( ) --------------------------------------------------------- Vanguard Long High 20% (15%) 8.7% Term Treasury (1.1) Vanguard Long High 10 (15) 2.9 Term Corporate (0.3) Vanguard CA Ins High 15 (10) 6.3 Long Term (1.9) (Note: Choose a fund for your own state; or, Van- guard Long Term Insured) PIMCO Total Medium 45 (50) 4.0 Return Instit (1.8) Vanguard High Medium 10 (10) 0.4 Yield (2.0) Finally, here are the remaining choices to complete our model portfolio. We have already discussed above our reasons for increasing our allocation to the REIT fund: "Other" Fund Categories ------------------------------------------------------- Suggested Year-to Fund Allocation; Date Last Return; Qtr.s Alloc. 3-31 to in ( ) 6-30-00 Return in ( ) ------------------------------------------------------- Vanguard REIT Index 50% (33) 13.3 (10.5) Vanguard Prime Money Market 50 (67) 3.0 (1.4) Note: As usual, my stock, bond, and other categories each separately add up to 100%. This should be helpful if you invest strictly in say stocks, allowing you to ignore the other categories if you choose. The 10% overall allocation to the Vanguard REIT Index recommended above comes about, for example, because if you invest 50% of the recommended 20% for "other", 50% of 20% comes to 10%. A Final Word No one, including you, me, Alan Greenspan, Abby Joseph Cohen, etc. is going to be able to correctly tell in advance exactly which investments are going to be the winners for an upcoming period. Therefore, some of the things any of us think about investments choices are NOT going to work out as predicted. My goal, and I think other rational people's also, should be to be correct a greater percentage of the time than we are wrong. If one has no chance to predict an outcome because that outcome is completely unknowable in advance, or because they do not have sufficient knowledge, then their rate of being correct should be about 50%. That is, 1/2 the time they will be right and 1/2 the time wrong. Such a rate obviously would offer no investment advantage. I would suggest that a "rate of being correct" percentage of approximately 2/3's (or better) would enable any investor to do extremely well indeed. Although far from perfect, this percentage would enable investor to be right twice as often as being wrong(67% right vs. 33% wrong). Put otherwise, for every losing, or at least so-so investment made, that investor would make two correct investment choices. Such an outcome could easily enable that investor to have a good retirement and the many other advantages of having some extra money accumulated. It's don't think it's for me to say whether or not I have been able to achieve that goal; but as long as I present both my forecasts and the later outcomes to the readers' of my newsletter and website, they can judge for themselves whether I have be able to accomplish this and been able to help the reader toward achieving such a goal too. Have a great Fourth of July! Tom Madell, Ph.D.