Dear friends.

Welcome to November, a quieting time in nature and one which gives us the opportunity to take a deep breath, rejoice that we’ve pretty much made it through another year, and give thanks for the people and events that have enriched our lives.

November was the ninth month in the old Roman calendar (hence its name, from “novem” for “nine”) and the residence of the American Thanksgiving holiday, which was celebrated intermittently until the presidency of Abraham Lincoln and annually thereafter.

In the midst of a civil war of unequaled magnitude and severity, which has sometimes seemed to foreign States to invite and to provoke their aggression, peace has been preserved with all nations, the order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere except in the theatre of military conflict …

No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Highest God. . . It has seemed to me fit and proper that they should be solemnly, reverently and gratefully acknowledged as with one heart and voice by the whole American people.

Abraham Lincoln, Proclamation of October 3, 1863

In 2021, anyway, it’s also the start of the Jewish Festival of Lights, of which it is said, “Hanukkah is not merely a cause for celebrations. It is a trial of perseverance.”

And, not least, the date of the American elections, which are – for all of their madness – free and peaceful, honest and fair. While this month’s elections – for school boards and city halls, primarily – don’t have the riveting drama of national contests, they are the lifeblood of our society. We need to care about our schools and our children; we need to care about our neighbors and our neighborhoods. We build large things at last by building small things first. That’s the essence of these thousand small votes. You should do your part in them.

Insider trading comes out

We mentioned, last month, the bipartisan and multi-branched celebration of insider trading, as both members of the Federal Reserve’s board of governors and a bipartisan collection of Congress members were flagged for trading on inside information.

This month adds to the roster. Another 43 members of Congress have failed to properly report their financial trades as mandated by the Stop Trading on Congressional Knowledge Act of 2012, also known as the STOCK Act. Senator Richard Burr of North Carolina is under investigation by the SEC for trades he and his brother made in February 2020; reportedly, the senator called his brother, who, within minutes, placed sell orders ahead of news of the effects of Covid. Burr had been privately briefed on the pandemic’s likely toll, though the Justice Department announced in January that they were not pursuing criminal charges. Fed chair Jay Powell did about the same: selling $5 million in Vanguard fund shares just ahead of the Covid bear.

All of which is sadly resonant with recent research findings, showing that rich people really are self-absorbed, entitled clods. “Emotional intelligence” is the ability to recognize and control our own emotions, but also the ability to recognize and influence other people’s feelings. It’s an incredibly important skill for managing stress, de-escalating conflict, building partnerships, and making the world a better place.

Ken and Karen have no emotional intelligence. Neither, as it turns out, do most people who are rich and recognize their superiority to others.

A series of studies published in Social Psychological and Personality Science found that people of higher socioeconomic status (SES) score consistently lower on tests of emotional intelligence, especially when they perceive high levels of inequality in their community. The researchers suggest that high SES and high subjective inequality promote increased self-focus and less motivation to attend to others’ emotions.

This might explain why it never even occurs to some of our elected and appointed officials that, perhaps, rules apply to them, too.

Time to think broadly

The Bank of America has now joined the “dead for the long term” party. They now project that the S&P 500 will return somewhere between zero and a bit below zero annually for the next ten years. That’s perfectly in line with Research Affiliates’ projection of a negative 0.5% annual return for the broad US stock market and wildly more optimistic than GMO’s regression-driven estimate of negative 7% annual returns for the next seven years.

There’s an argument for thinking a bit broadly. We’ve profiled Standpoint Multi-Asset Fund this month, one of the entrants in the “permanent portfolio” derby. Standpoint argues that traditional asset class returns are positioned for long-term stagnation, and they strive to add non-traditional asset classes as a buffer. Similarly, it might be wise to give greater weight to dividends as part of your portfolio strategy. High dividend yield corporations are often in mature, slower growth industries, whose dearth of growth opportunities explains why they have the cash to hand back to shareholders.

Funds whose mandates give equal importance to income and growth are classified as Equity Income funds. I did a quick screen for the Equity Income funds with the best risk-adjusted returns. These are all MFO Great Owls. Since the strategy is a bit old-fashioned, you shouldn’t be surprised that most of these funds have a record spanning decades. And you should be pleased that, by the nature of the Great Owl metric, these are funds that have been consistently in the top tier of their class. For the sake of comparison, we’ve also included Vanguard Total World Stock Index as a quick benchmark.

Equity Income / International Equity Income Great Owl Funds, five-year returns

Sorted by Sharpe ratio

Thanks, in a season of thanksgiving …

To our loyal supports, Paul, John, Wilson, the folks at S&F Investments (hey guys, I owe you a fund profile), Brian, William, and the other William, David, Doug, and Greg. As we work through the knotty questions (ahem, not “naughty”) of MFO’s future, your continued faith and support means more than you could know.

Likewise, for Shadow and Ira and all of the good folks on the MFO Discussion Board… Ya give us reason to get up each morning!

See you when the snow flies,

I have a deep distrust of managed futures funds. The logic is simple: isolate asset classes that are uncorrelated, invest only in the uptrending assets, ignore (or short) the losing classes, and you get a long, smooth ride to prosperity.

The research behind them is so beautiful and compelling. Various backtests suggest that a managed futures strategy would have returned 13.5% annually for the period 1972-2010.  During that same period, the equity market would have returned 9.8% annually. On top of it, the managed futures strategy would have been less volatile.

Their performance, on whole, is so wretched and bewildering. Over the past five years, the average (surviving) managed futures fund returned 0.7% a year with a maximum drawdown of 17.7% and a negative Sharpe ratio. A well-run lemonade stand would have made you more money with less heartache. There is no group that was more frequently featured in the “Dustbin of History” column than managed futures, a trend that was diminished only when we started running out of managed futures funds to liquidate.

Standpoint Multi-Asset (REMIX / BLNDX) might force me to reconsider my biases.

The fund is managed by Eric Crittenden, who co-founded Longboard Asset Management in 2010 and launched the Longboard Managed Futures Fund (now Longboard Alternative Growth LONGX) in 2012, eventually building the firm’s assets to $500 million.  He was Co-CIO and Co-Portfolio Manager for Longboard from August 2011 to August 2018, launching Standpoint Asset Management in August 2019.

Mr. Crittenden and I chatted over the summer, and we’ve been following the fund since then. It was an interesting conversation and, really, he had me at

I hate managed futures. I sold them for years at a 3% fee, driven by the argument that all portfolio optimizers agree that you should have 30-50% managed futures all the time. It’s like the advice, take your vitamins. That’s great if you can get them in the form of Gummi Bears but it can be horrible otherwise.

You’ve got to drill down to individual models, especially commodity-heavy ones. Commodities should be able to add valuable diversification to a portfolio but long-only commodities as a whole are money losers over time, in part because they’ve got a 12-30% cost to carry (for storage, insurance, etc.).

The strategy seems sensible and straightforward. The fund provides exposure to equities (which help in times of economic growth or inflation), fixed income (which buffers deflationary periods and stock market declines), and commodities (which are uncorrelated with the first two, making it possible to minimize the effects of both sustained price changes and of an equity market decline). Half of the portfolio is invested in low-cost ETFs to give exposure to the global equity market. The argument is simple: over time, equities make serious money, especially if you don’t overpay for them. The fund holds eight equity ETFs charging between 3 and 7 basis points.

The other half of the portfolio is managed futures positions. The positions can be in stocks and fixed income, as well as currencies and commodities. “Once a year we pull down the information on all the future contracts in the world, arrayed from most liquid to least liquid. We exclude the untradeable, then select the 75 most liquid in six sectors which includes equity index futures, bond futures, currencies, metals, energy, and agricultural commodities.” Using a market following strategy, the futures contracts allow the portfolio’s exposure to equity markets to be increased beyond its 50% base (it was at 65% in mid-summer) or decreased to near zero.

We compared Standpoint against its two plausible peer groups for the longest standard period available, 18 months. In each metric, the best value is signaled by green highlighting.

Performance from April 2020 – October 2021

Source: Lipper Global Data Feed, 4/20 – 10/21, from MFO Premium

The performance of the strategy, since inception, against a global equity portfolio, is pretty striking. The same color scheme applies.

Source: Morningstar Direct, 12/30/19 – 9/30/21, from Standpoint

Much of that advantage comes from the one thing you most want in an all-weather portfolio: protecting you from the storm.

Ultimately, the fund should provide three sources of gain. The equity risk premium, the risk-free gains from T-bills and TIPS, and a risk-transfer premium that comes from providing liquidity to hedgers. That’s allowed them to generate a negative beta in bear markets.

The argument for Standpoint is much like the old argument for managed futures: it can provide absolute positive returns with muted volatility even when the equity markets correct or the fixed-income markets are priced to return less than zero in the immediate future.

“Our edge,” he says, “is that we know how to build a good macro program without the traditional 2 & 20.” It is designed to be a permanent piece of your portfolio: simple, durable, and resilient.

It’s worth investigating. The fund’s website is pretty low flash but has a fair amount of information and several video interviews. The fund charges 1.53% (after waivers) for Investor shares whose minimum purchase is $2,500.

I divide my investing strategy into the low cost, buy and hold philosophy following that of Vanguard, and its founder, John Bogle, along with Charles Ellis, and the more active business cycle approach of Fidelity, Benjamin Graham, Howard Marks, and Ed Easterling, with a touch of trend following from Gregory L. Morris using a risk-managed approach of Mutual Fund Observer, the bucket approach of Morningstar, and the tax strategy that I learned late in life. Whew! This article describes how I try to make sense of it all planning for retirement, and still focus on keeping it simple. I set a different strategy for different accounts to take advantage of the strengths of the financial institution, funds, and account type. Keep It Simple but Significant!

The amount of conflicting financial advice each of us is bombarded with never ceases to give me pause…

“How can you not invest in the future of America?” one guest will ask whole heartedly. While the next will state “US markets are all over-priced by every historical measure.” And, each provides passionate and convincing arguments.

Others argue for buy-and-hold strategies, while just as many others argue for trend following. Both camps devoted to their positions.

My colleague David Snowball offers one way of dealing with the conflict. Basically, nobody wants their funds (or the advice they follow) to suck…

So, David is constantly asking himself: Do the recommendations given, implicitly or not, by us or others, suck?

– How Well Do MFO Great Owls Perform?, MFO August 2019, Charles Boccadoro

I have been simplifying my accounts with one Vanguard traditional IRA described in this article that uses five buy and hold core funds, but with a tactical sleeve for 15% of the assets. It has a global focus with a tilt toward large-cap value. Next month’s article will describe a traditional IRA at Fidelity that follows the business cycle approach and is my attempt to “row instead of sail” using multi-asset, real return, and more tactical funds. These two accounts are conservative, with a stock and “other” ratio of about 45% to bonds, because taxes will have to be paid on them. I have set up a Roth IRA as a Fidelity Managed Account which is more aggressive, with about 75% stocks, because taxes have already been paid. Overall, including employer stock plans and a bucket for three years of living expenses, my portfolio is 55 percent stocks and “other” resembling a “balanced” portfolio with a large tilt away from technology toward core funds and a small tilt toward small and mid-cap funds.

Each investor’s situation is different and my intermediate objective is to keep income low until I begin drawing social security and required minimum distributions in order to convert traditional IRAs to Roth IRAs while income is low. This strategy works well for those with pensions and the cash to pay for the taxes on the conversions. One of my next quests is to work with a financial planner specializing in taxes to implement this strategy.

1.  Vanguard Traditional IRA Strategy

Starting valuations matter. Global stocks this year have continued to rally from pandemic lows, and that will make further gains harder to come by. In fact, our 10-year annualized return forecasts for some developed markets are nearly 2 percentage points lower than they were at the end of 2020…

U.S. stocks: 2.4% to 4.4%; ex-U.S. stocks: 5.2% to 7.2%.

– Vanguard

I wanted to build a simple strategy for a traditional IRA using the Vanguard strategy and funds as much as possible. Taxes will have to be paid on this portfolio as required minimum distributions take effect so I want to be more conservative in this portfolio, and more aggressive in a Roth IRA. This portfolio is a candidate for at least a partial conversion to a Roth. Bear markets may be an ideal time to convert to a Roth and I will be watching for this opportunity.

What some people may not realize is that Vanguard manages $1.6 trillion in actively managed funds. They claim that over the past 10 years, 86% of their actively managed funds outperformed their peer groups. Another misconception about the Vanguard philosophy may be that you should blindly set an allocation and hold it or adjust it for the remaining years until retirement. In 1999, the founder of Vanguard, John Bogle, was “concerned about the (obviously) speculative level of stock prices.” Mr. Bogle reduced his equity exposure to about 35 percent of assets, which he held through the time of writing Enough: True Measures of Money, Business, and Life in 2010:

Clearly, investors would have been wise to set their expectation for future returns on the basis of the current sources of returns rather than fall into the trap of looking to past returns to set course. That dividend yield as 2000 began was at an all-time low of just 1 percent and the P/E at a near record high of 32 times earnings together explain why the average return on stocks in the current decade is at present running at an annual rate of less than 1 percent.

By comparison, the price-to-earnings ratio is currently estimated to be 29. One difference is that we are now in the mid-cycle stage of the business cycle where earning may have room to grow as opposed to the late stage of the business cycle in 2000. I also want to apply some form of Benjamin Graham’s (Warren Buffett’s mentor) guideline of investing no less than 25% in stocks and no more than 75% depending upon valuations:

As an alternative policy he [an investor] might choose to reduce his common-stock component to 25% ‘if he felt the market was dangerously high,’…

– The Intelligent Investor (1973), page 5, Benjamin Graham

Vanguard offers eleven sector ETFs from a total of 76, which can be used to tilt a portfolio according to one’s view of the investment environment.

I have finalized the strategy of this traditional IRA to own four Vanguard mixed funds and Columbia Thermostat (COTZX) to have five core funds with allocations that range between 10% and 25% that will make up 85% of the portfolio. The other 15% is a tactical sleeve of mostly Vanguard sector ETFs and trending funds to adjust according to the business cycle. The neutral stock to bond allocation for this portfolio is 45% where it is now, but at extremes in the business cycle, this may be as low as 30% or as high as 65% depending upon what I own in the tactical sleeve and Columbia Thermostat. This range is a gradual change over the business cycle and not an attempt for short-term timing of the market.

2.  Best Funds Over Twenty Five Years

More than anything, we believe investors should be using all of the tools in their toolbox to meet goals and objectives. This means deploying an active investment approach with the ability to generate beyond passive benchmarks.

There is no such thing as ‘easy money,’ and lower returns should be expected. We know it may not be what investors want to hear, but this type of clear-eyed, realistic approach to risk management is the only way we know how.

– Cruising Through The Economic Cycle, Manning & Napier

For the Vanguard Portfolio, I want a portfolio with low turnover, and I look to the very short list of existing funds that consistently outperformed over the past twenty-five years. The funds below are the ones that I find most attractive, and Vanguard’s low-cost philosophy is a winning philosophy. For the next ten or more years, with high valuations in the US, stimulus wearing off, large debts and deficits, and the speculative nature of current markets with high margin leverage, we are likely to see lower domestic returns relative to international along with more volatility and with at least some “less than transitionary” inflation. The Wellington Management Fund has managed the Vanguard Wellington and Wellesley funds since inception and now manages two global versions of these funds.

What the table points out is that the funds are conservative (MFO Risk =2) to moderate (MFO Risk =3) while the Lipper Category classifies them as conservative, moderate, and growth. The names in blue indicate the funds that have the MFO Great Owl Classification for high-risk adjusted performance. Martin Ratio is the risk-adjusted performance. I added the column for percent equity as another measure of risk (and returns), and percent domestic allocation to show that while many of these funds have done well, they have invested largely in the US which now has much higher valuations than many other markets. Vanguard Wellesley Income (VWIAX) is a great conservative fund that invests mostly domestically.

Table #1: Best Funds Over Twenty Five Years

Source: Created by the Author Using MFO Premium screener and data

For the more aggressive funds in the traditional IRA at Vanguard, I select the Wellington and STAR funds. For the more conservative fund, I like the Wellesley fund.

3.  Vanguard Core Funds

Vanguard Global Wellington Admiral (VGWAX): The equity portfolio holds about 90 stocks and tilts to mega-caps. Key holdings since its November 2017 inception include Bank of America BAC, Microsoft MSFT, and Novartis NVS. Industrials have been overweight, anchored by defense companies such as Lockheed Martin LMT, which has a strong record of increasing dividends. A notable underweighting is technology, but the team likes semiconductor names, as they feel that after a period of consolidation, the top firms are now more effectively using technology as a source of competitive advantage. Non-U.S. names account for about half of the equity sleeve and include holdings like Taiwan Semiconductor TSM and AstraZeneca AZN.

– Morningstar, Patricia Oey

Table #2 shows my favorite Vanguard mixed-asset funds with metrics for the past two years. My expectation is that global funds, which have performed relatively poorly for the past few years, are likely set to outperform over the next five to ten years due to lower international valuations. The Global Wellesley and Global Wellington Funds have higher allocations (close to 45%) to international stocks with a strong tilt toward value.  If you are interested in information about the Vanguard Funds in this article, I refer you to Vanguard Global 60/40 Funds.

The Vanguard Global Wellington has a price-to-earnings ratio of 18.6 compared to 25.5 for the Vanguard Wellington Fund. Investors are paying 37% more per dollar of earnings to own the Wellington instead of the Global Wellington fund. The global funds have been more volatile compared to domestic versions because of additional currency and country risks.

Table #2: Best Vanguard Core Fund Metrics – Two Years

Source: Created by the Author Using MFO Premium screener and data

The one-year trends in Figure #1 show the funds in the Mixed-Asset Growth Category have performed similarly as we shift from the Recovery to the Middle Stage of the business cycle. Likewise, the Global Wellesley is performing about as well as the Wellesley Income Fund. This may represent an inflection point for performance from growth to value and domestic to international.

Figure #1: Best Vanguard Core Fund Metrics – One Year

Source: Created by the Author Using Vanguard

I selected the Global Wellington and STAR Funds for the more aggressive side of the portfolio partly because they are more global, and the Wellesley Fund as the more conservative, domestic side of the portfolio. The Global Wellesley Fund is more of an unknown to me, and I selected it as a conservative global fund, but have a lower allocation to it.

4.  Vanguard Sector Funds

Although we do not believe the pillars are yet in place to support a 1970s-style stagflation scenario, we are clearly in a weakening growth/high inflation era that appears less “transitory” every day…

Interdependencies, coupled with low inventories across global supply chains, have ushered in a brittle system that’s become more vulnerable to shocks and their ripple effects.

– The Beast of Burden of Inflation, Liz Ann Sonders from Charles Schwab

The tea leaves are difficult to read for sector funds because August to October has been volatile with a small dip. While valuations are high, we are in the middle stage of the business cycle which is typically the longest-running stage of the business cycle. The price-to-earnings ratio of the S&P 500 appears to be declining as earnings increase. With ample stimulus, there is probably more room to run before the next recession. Other risks include inflation, tapering on bond purchases by the Federal Reserve, volatility, and of course the “unknowns”. The past couple of months has been a good time to adjust allocations and pick up new funds.

Table # 3 shows most of the Vanguard Sector Funds. Those in the top two sections (eight funds) typically do well in the late stage of the business cycle. Those in the top section (five funds) are trending higher and may be more favorable for the next year or two. Those in the bottom section are what I want to underweight as they do well in the Recovery stage, but may now be more over-valued. The Vanguard Commodity Strategy Fund has had strong trends but has seen some withdrawals recently. I am holding, but watching as I read some consumer staples such as food and natural gas for home heating continue the trend of higher prices.

Trend Exponential Moving Average (EMA) measures the price of the fund compared to its moving average which weight more recent months heavier. A positive value shows the fund is increasing in value compared to its trend. Price to Cash Flow (P/C) is the price relative to the cash the fund generates.

Table #3: Vanguard Sector Funds

Source: Created by the Author Using Mutual Fund Observer

Investors should always have a Plan B for other funds. Figure #2 contains some Plan A tactical funds such as Commodity and Consumer Staples, along with Plan B funds such as real estate funds, mid-cap value funds, and emerging markets. When the Plan B funds are accelerating faster than the Plan A funds then it may be time to see if there is a storyline for making a change. I recently added the American Funds New World Fund Class (NWFFX) in another account because it underweights China and is more diversified including companies from developed countries that do business in emerging markets. Another interesting ETF that has performed well is the BlackRock iShares MSCI Emerging Markets ex-China (EMXC) which invests in emerging markets excluding China.

Figure #2: Trending Funds

Source: Created by the Author Using Vanguard

I include the Vanguard Commodity Strategy Fund and the Consumer Staples ETF in the Tactical Sleeve but have added Health Care in the traditional IRA at Fidelity. These categories tend to do relatively well in the late stage of the business cycle. I have also added an emerging market and mid-cap value fund in the traditional IRA at Fidelity. For those wishing to hedge against inflation without buying commodities, I suggest that you look at Horizon Kinetics Inflation Beneficiaries ETF (INFL) which invests in companies that will benefit from inflation, but with a caution that like commodities it will likely be volatile.

5.  Setting a Target Allocation (aka Cycle Inflection Points)

In my view, the greatest way to optimize the positioning of a portfolio at a given point in time is through deciding what balance it should strike between aggressiveness/defensiveness. And I believe the aggressiveness/ defensiveness should be adjusted over time in response to changes in the state of the investment environment and where a number of elements stand in their cycles.

– Mastering the Market Cycle: Getting the Odds on your Side, Howard Marks, co-founder of Oaktree Capital Management

You are driving along at 50 miles an hour and step on the accelerator. Your car speeds up. You let off the accelerator and the car slows down, but you are still moving. The same concept applies to the economy. Fidelity estimates that the economy has moved from the recovery stage to the middle cycle which means the economy is still growing, but at a slower rate (deceleration). Mutual Fund Observer Multi-Screen has a new tool called the Trend EMA for the exponential moving average for three- and ten-month periods. This can be applied to funds as I show in this article. The fund price may be growing at a faster rate (acceleration) or slower rate (deceleration). The point at which acceleration turns positive or negative is an inflection point where the fund may still be growing, but at a slower or faster rate than previously.

I believe that we are in secular and business cycle inflection points. Inflection points with high valuations, slower growth rates, and inflation are usually followed by secular bear markets where returns are lower than historical averages. Stocks may rise, but valuations often fall. Valuations are the best long-term determinant of returns, but not a short-term timing metric. For the business cycle, the middle stage is usually the longest. The economy is growing strongly but will grow slower than it did during the recovery stage.  

As an example of secular markets and business cycles, Figure #3 shows the conservative Vanguard Wellesley (VWINX) compared to the more aggressive Vanguard Wellington (VWELX) and S&P 500 since 1995. The Wellington and S&P500 did not consistently outperform the conservative Wellesley for the 20 year period containing the bursting of the Technology Bubble and Great Financial Crisis. For the past twenty-six years, the S&P500 has not significantly outperformed the Wellington fund. Entering retirement, my time horizon is likely less than 25 years. I expect lower than historical returns with high volatility. In this environment, I like an active approach rather than a passive one.

Figure #3: Secular Trends

Source: Created by the Author Using Portfolio Visualizer

We, as individual investors, can’t time the markets on a consistent basis but we can adjust the risk of our portfolios to match the investment environment. Because I believe that some underperforming funds such as international and small caps may be set to outperform, I did not choose funds to include in the portfolio based on historical performance. Instead, I chose funds that have performed relatively well in categories that I expect to outperform in the future. I want to have a target allocation but tilt toward growth in the recovery stage and defense in the later stages. Coincidently, my overall allocation is 55 percent. I would be comfortable with a 30 percent allocation to stocks in the late stage of a business cycle and 65 percent during the recovery stage.  

Implementation is more difficult. This is one reason for building a multi-strategy portfolio. The goal is that each portfolio does well, but they and some of their funds will outperform at different times. Both the Vanguard and Fidelity Portfolios contain Columbia Thermostat (COTZX/CTFAX) which will allocate between 10 and 90 percent to stocks based on valuations using the philosophy of “buying low and selling high”. It is mostly in bonds now and will underperform many mixed-asset funds until the next correction. For more information about Columbia Thermostat, please read Tactical Sleeve for the Conservative Minded. There is always a bear market on the horizon, and I expect the next one in two to five years from now. This is not a forecast, just a historical reality…

“History doesn’t repeat itself, but it often rhymes.” – Mark Twain

6.   Vanguard Traditional IRA Portfolio

The simplest form of adjusting portfolios to the business cycle is to own four to six funds and adjust allocations during regular quarterly or annual rebalancing. For those who want to be more active, you may add a few sector funds or rotate between growth and value funds. Portfolios should remain diversified in each stage of the business cycle.

– Business Cycle Portfolio Strategy, MFO December 2019, Charles Lynn Bolin

The above concept that I described in 2019 is what I am implementing with the traditional IRA at Vanguard. I am more heavily invested in Vanguard Global Wellington because it has a higher allocation to stocks, has a value orientation, is more global, and has the experience of the Wellington Management Team. I have a high allocation Vanguard Wellesley as a more conservative domestic fund. In other words, I set allocations based on gut feel where I believe we are in the business and secular cycles and will adjust the tilt based on trends.

The four Vanguard Funds that I am invested in are Vanguard Global Wellington (VGWAX), Global Wellesley (VGYAX), and Wellesley Fund (VWIAX). The Vanguard STAR Fund (VGSTX) is an excellent fund that I want to own more of during the recovery stage of the business cycle. It is a fund of funds including the venerable Windsor and PRIMECAP Funds, and overall has a tilt toward growth. I include the Columbia Thermostat Fund (COTZX) because it adjusts allocations according to cyclically adjusted price to earnings. Thermostat did not perform well following the Great Financial Crisis but has since changed its strategy to gradually change allocations instead of consisting of all stocks or bonds. It performed extremely well during the 2020 bear market.

I allocate 15% to a tactical sleeve based upon funds that do well in the coming stages of the business cycle, as well as momentum and valuations. In the tactical sleeve, I own the Vanguard Commodity Strategy Fund (VCMDX) which has exhibited lower risk than most commodity funds. I also recently bought the Vanguard Consumer Staples ETF (VDC). The tactical sleeve often consists of higher risk funds (MFO Risk = 4).  The portfolio is moderate (MFO Risk = 3). The maximum drawdown of this portfolio would have been around 11 percent during the 2020 bear market, and the return would have been around 12 percent.

The allocation to stocks and commodities of this portfolio is 43%, of which just under a third is international. As per the strategy described in Section #1, I will be bringing the allocation to the STAR fund up to the minimum of 10% as I rebalance. I will also be looking to reduce the allocation of the Commodity Strategy Fund over time down to 5% as per the strategy of this portfolio.

Table #4:  Vanguard Traditional IRA Portfolio (Two Years)

Source: Created by the Author Using MFO Premium screener and data

7.  Closing

My wife and I built a relationship with a Fidelity Advisor which includes having a managed Roth IRA account. It is a comfort for my wife to know the financial plan and situation, and I want to know that she has someone to go to for advice in case something happens to me. He is a personal advisor, familiar with my situation and preferences. What I liked is that he asked my opinion and went along to rationalize decisions together. We will make adjustments as required going forward. I also like Vanguard for its great funds and like to diversify to some extent across financial institutions.

Just trying to keep it simple…

“Everything should be made as simple as possible, but no simpler.”

– Albert Einstein.

Best Wishes and Stay Safe!

There is an ongoing debate about whether Chinese President Xi’s economic reforms fundamentally threaten the investment case for China (and, by extension, for the emerging markets universe which China dominates). The Economist warns that “China’s new reality is rife with danger” (10/2/2021):

His campaign is remarkable for its scope and ambition. It started to rumble in 2020, when officials blocked the initial public offering of Ant Group, an affiliate of Alibaba, a tech giant. It is thundering onward, having so far destroyed perhaps $2trn of wealth. Didi, a ride-hailing outfit, has been punished for listing its shares in America. Evergrande, an indebted property developer, is being driven towards default. Trading on cryptocurrency exchanges has been banned as, more or less, has for-profit tutoring. Gaming is bad for children, so it must be strictly rationed. China needs larger families, so abortion must become rarer. Male role models should be manly and celebrities patriotic. Underpinning it all is Xi Jinping Thought, which is being drummed into the craniums of six-year-olds.

The question is whether Xi’s campaign will merely suppress excesses (which are innumerable) or, by intent or error, overshoot and fundamentally damage the global economy. The good folks at Matthews Asia, surely among the most experienced China investors in the public sphere, are cautiously in the former camp. Andy Rothman’s recent video blog, “What is Xi Jinping Thinking?” (10/2021) argues that the Chinese elite know that private wealth has been the goose that laid the golden egg, and they’re surely not going to kill it. They might make tactical errors in dealing with the excesses but they’re likely to steady the system after a quarter or two. “How worried should we be?” They are “prone to overdoing it” but are “swift to course correct.”

Others are more cautious. Andrew Foster, the founder of Seafarer of reflected in 2021:

In my view, China has always held the greatest promise – possibly more than all other emerging markets combined … For the past three decades, my academic studies and professional career have been heavily influenced by an abiding interest in China’s practical and largely successful effort to escape mass poverty. Over time, my understanding of the country’s economic progress had manifested in a formative idea of China’s emergent potential. However, that year I was forced to recognize that my hopes for China’s future were naïve. From 2013 onward, President Xi and his administration have explicitly imagined a very different “Chinese Dream.” 

Mr. Foster speculates that China might need to become its own asset class if EM investing is to remain viable. Goldman Sachs just raised the same prospect.

The October 2021 letter from Grandeur Peak’s Robert Gardiner reflects are similar caution:

Our view for now (emphasis added) is that China is still a place we want to be investing, though we aren’t blindly moving ahead. We’re staying cautious.

Recent Chinese moves against aggressive capitalism have not been subtle. This has crushed certain industries in the Chinese stock market. We’ve been hurt by this, but not too badly. Some of the move against capitalism may be healthy. China has had a tremendous amount of fraud, which we believe might be reined in, and many companies in China are overly aggressive and perhaps this will add some caution, which could also be healthy. Understanding China is so important to understanding the global landscape, including the United States. We’re sticking with our investments in China for the time being (again, emphasis added).

A fair number of funds have issued updated statements concerning the risk of investing in China. The largest China fund, iShares MSCI China ETF, issued an expanded warning in September. The revised warning runs to 5,000 words and includes a clear statement on the risk of investing in dictatorships:

The Chinese government is authoritarian and has periodically used force to suppress civil dissent. Disparities of wealth and the pace of economic liberalization may lead to social turmoil, violence and labor unrest. In addition, China continues to experience disagreements related to integration with Hong Kong and religious and nationalist disputes in Tibet and Xinjiang. There is also a greater risk in China than in many other countries of currency fluctuations, currency non-convertibility, interest rate fluctuations and higher rates of inflation as a result of internal social unrest or conflicts with other countries. Unanticipated political or social developments may result in sudden and significant investment losses. China’s growing income inequality, rapidly aging population and significant environmental issues also are factors that may affect the Chinese economy.

BlackRock’s version of the alarm, in their own updated risk statements, includes the note:

Investments in securities of companies domiciled in the People’s Republic of China involve a high degree of risk and special considerations not typically associated with investing in the U.S. securities markets. Such heightened risks include, among others,

• • • an authoritarian government,
    • popular unrest associated with demands for improved political, economic and social conditions,
    • the impact of regional conflict on the economy
    • hostile relations with neighboring countries
    • Military conflicts, either in response to internal social unrest or conflicts with other countries …
    • The Chinese economy is vulnerable to long-running disagreements and religious and nationalist disputes with Tibet and the Xinjiang region.
    • Since 1997, there have been tensions between the Chinese government and many people in Hong Kong … Recent protests and unrest have increased tensions even further.
    • China has a complex territorial dispute regarding the sovereignty of Taiwan and has made threats of invasion
    • China is alleged to have participated in state-sponsored cyberattacks against foreign companies and foreign governments.
    • China could be affected by military events on the Korean peninsula or internal instability within North Korea.
    • there can be no assurance that [Chinese economic and market} reforms will continue or that they will be effective.
    • The Chinese government may intervene in the Chinese financial markets, such as by the imposition of trading restrictions, a ban on “naked” short selling or the suspension of short selling for certain stocks.
    • there is less regulation and monitoring of the securities markets and the activities of investors, brokers and other participants in China than in the United States.

A side-by-side comparison with earlier notes highlights three substantial additions:

Chinese companies are also subject to the risk that Chinese authorities can intervene in their operations and structure.

Additionally, China is alleged to have participated in state-sponsored cyberattacks against foreign companies and foreign governments. Actual and threatened responses to such activity and strained international relations, including purchasing restrictions, sanctions, tariffs or cyberattacks on the Chinese government or Chinese companies, may impact China’s economy and Chinese issuers of securities in which the Fund invests.

Chinese companies, including Chinese companies that are listed on U.S. exchanges, are not subject to the same degree of regulatory requirements, accounting standards or auditor oversight as companies in more developed countries. As a result, information about the Chinese securities in which the Fund invests may be less reliable or complete. Chinese companies with securities listed on U.S. exchanges may be delisted if they do not meet U.S. accounting standards and auditor oversight requirements, which would significantly decrease the liquidity and value of the securities. There may be significant obstacles to obtaining information necessary for investigations into or litigation against Chinese companies, and shareholders may have limited legal remedies.

China is a problem for your portfolio. As one of the world’s two largest economies and one of the world’s two largest stock markets, you can’t really avoid it. A US-only portfolio is still full of gaming and tech companies (Intel, Broadcom, Micron, Texas Instruments, AMD) who derive 20 – 70% of their earnings from China.

While reporting on China exposure is spotty – companies don’t have to break out earnings by country or region – lots of consumer names, from Yum Brands (Taco Bell, Pizza Hut, KFC) to UnderArmour and Nike, are dependent on China for billions in revenues.

Likewise, your international holdings have surprising exposure to Chinese stocks. Seven of the 10 largest holdings of the troubled Evergrande Property Services Group are Vanguard index funds, not overly Asian. And Evergrande is not alone in its financial woes: Sinic Holdings likely won’t repay $250 million worth of bonds and China Properties Group has defaulted on $226 million worth of notes.

To get a measure of the implied exposure to China (and its woes), we used the screener at MFO Premium to calculate the correlation between the largest China fund (iShares MSCI China ETF) and various sets of international investments.

Emerging markets: The 10-year correlation of the Vanguard Emerging Markets Index, a surrogate for EMs generally, and iShares MSCI China, the largest China ETF, is 0.84. Artisan Developing World, an MFO Great Owl, is just a touch behind at 0.81. The 10-year correlation for the largest EM funds is 0.74 – 0.84.

Emerging markets small-cap: 0.57 – 0.66

Frontier markets: 0.43 – 0.64

– – – – –

International large-cap growth: 0.61 – 0.78 (Vanguard International Growth is highest)

International small-mid growth: 0.63 – 0.69

International small-mid value: 0.60 – 0.64 

International large cap value: .048 – 0.55

The bottom line: the strongest China exposure, not surprisingly, is in mainstream EM equity funds. If you’re looking for EM exposure, prefer small caps to large caps, and frontier markets to more mature emerging markets.

If you’re looking for broad international exposure, international large growth – the default category for the largest international funds these days – has the highest correlation, international large value has the lowest with international small caps in-between.

One place to start your portfolio exploration is with the international Great Owl funds that favor smaller markets, smaller market caps, and smaller valuations. The Great Owl designation means that the fund in question has landed in the top 20% of its peer group, based on conservatively risk-adjusted returns, for the past 3, 5, 10, and 20 years, as applicable based on the age of the fund. The funds listed below all have track records of five years or more and have earned the Great Owl designation.

The complete list of all 700 Great Owl funds and ETFs is available at MFO Premium.

Small Cap emerging markets and frontier markets

Virtus KAR Emerging Markets Small Cap (VIESX)

Oberweis Emerging Markets (OBEMX)

International Small / Mid-Cap Growth

Wasatch International Opportunities (WAIOX)

Virtus KAR International Small-Mid Cap (VIISX)

WCM International Small Cap Growth (WCMSX)

Brown Capital Management International Small Company (BCSFX)

Grandeur Peak International Stalwarts (GISYX)

International Large-Cap Value

AMG River Road International Value Equity (ARLSX)