By Charles Lynn Bolin

The Mutual Fund Observer writes for the benefit of intellectually curious, serious investors— managers, advisers, and individuals—who need to go beyond marketing fluff, beyond computer-generated recommendations, and beyond Morningstar’s coverage universe.

The quote above had a big impact on me in July 2019 when I was first introduced to Mutual Fund Observer, and I became its most enthusiastic fan. I began contributing to the monthly newsletter shortly thereafter. I appreciate the efforts that have gone into creating and maintaining MFO by Professor Snowball, Chip, Charles Boccadoro, Barb Bradac, and Edward Studzinski. You greatly contributed to the financial well-being of so many people. I appreciate that the Premium Service will continue. Thank you.

I would also like to wish all Readers a happy and prosperous New Year. With the MFO newsletter transitioning to new voices after this month, my final article for MFO is the third of a three-part series describing how I have simplified my portfolios using a bucket approach, the business cycle, and of course, the MFO Premium Multi-Screener Tool. Bucket #1 contains three years of living expenses, Buckets #2 and #3 are conservative, traditional IRAs at Vanguard and Fidelity, and Bucket #4 is a tax-efficient after-tax portfolio still in planning. This article describes Bucket #5, which is a Roth IRA managed by Fidelity using the business cycle model.

This article covers the following sections, and readers may skip to the sections of interest. The Key Point is summarized at the beginning of each section for those with limited time.

1. Wealth Management Options at Fidelity
2. Asset Allocation Strategies through the Business Cycle
3. Model Portfolios at Fidelity
4. Model Portfolios at Fidelity Institutional
5. Fidelity Business Cycle Portfolio

I have created two Watchlists, each with one hundred funds, in MFO Multi-Search for tracking funds available at Fidelity and Vanguard. The Watchlists are available following the Closing in this article along with my ranking of some of these funds based on recent trends. I also identify top-performing funds from Brown Advisory and Grandeur Peaks for further research to determine if I want to add them to the Watchlists.

1.   Wealth Management Options at Fidelity

Key Point: There are many Fidelity investment services available to investors with wide ranges of experiences and needs.

I found the post by Bolin “Building a Multi Strategy Portfolio” very
instructive. Building a Multi-Strategy Portfolio – Fidelity Traditional IRA… While this portfolio is just one of his- the “Fidelity Traditional IRA“… I found myself wondering about one sentence he mentioned “a Bucket for a more aggressive Roth IRA managed by Fidelity”… What funds might be in that Roth?

-MFO Discussion Board, JonGaltIII

Please see descriptions of those funds included in the “more aggressive Roth managed by Fidelity” in Section #3, Mr. Galt.

I have been using the Fidelity Retirement Calculator for years and discussing retirement planning once a year with a Fidelity Advisor. The Fidelity website for Planning and Advice offers the following services depending upon an investor’s needs:

Table #1: Fidelity Planning Services

Service	Description	Minimum	Fees
Fidelity Go	Robo advisor	$0	0.35% > $50,000
Personalized Planning & Advice	Digital investing + coaching	$25,000	0.5%
Wealth Management	Planning & advice from a dedicated advisor	$250,000	0.50%–1.50%
Private Wealth Management	Planning & advice from an advisor-led team	$2 million managed through Fidelity Wealth Services	0.20%–1.04%

Fidelity offers the option of using an independent advisor and has low-cost index services available. The Fidelity Institutional website covered in this article is for advisors, but it was worth my time to research the site and see what is available. In the Wealth Management services, one of the choices to be made is whether you want a portfolio based on Fidelity Funds, a Blended Approach with funds from other families, and an Index Approach.

In starting a Managed Account, I had a remote working session with my dedicated personal advisor and a Senior Portfolio Specialist to discuss goals and possible solutions. I elected to use the business cycle model portfolio with the Blended Approach for funds. “Investment Team Perspectives” at the Fidelity website provides a good summary each month of the Investment Team’s views including Market Backdrop, Positioning, Performance, and Outlook. They explain changes to allocations that are made.

2.   Asset Allocation Strategies through the Business Cycle

Key Point: My base case is a 50% stock and 50% bond and cash portfolio that tilts 15 points higher during the Recovery Stage and 15 points lower in the Late Stage.

At Fidelity, we believe:

• • Asset allocation is the single most important factor in assessing the long-term risk and return characteristics of a diversified portfolio.
  • Efficient portfolio diversification can be one way to lower a portfolio’s risk while maintaining its expected return.

I am a believer in Ed Easterling’s philosophy about secular markets. He is the founder of Crestmont Research and the author of two books on market cycles. Mr. Easterling’s philosophy is that secular bull markets are a time for a “sailing” approach (ie using low-cost index funds), and secular bear markets are a time for a “rowing” approach. Investing along with the business cycle is a form of rowing. I want a portfolio that manages risk based on the business cycle along with the philosophies of Benjamin Graham who advocated having no more than 75%, nor less than 25% allocated to stocks and Howard Marks who advocated adjusting your level of aggressiveness/defensiveness to the environment.

The following table is a good starting point for understanding investing according to the business cycle. The Mid-Cycle is typically the longest. In the current situation with near full employment, higher than normal inflation, loose monetary policy, the foundation is set for monetary tapering and rising rates shifting us into the Late Stage within the next year or two. We should be looking at what does well not only in the Middle Stage of the business cycle but also in the Late Stage with a watchful eye on the next recession.

Figure #1: Typical Business Cycle

As we move through the business cycle we can rotate through sectors that perform well by stage as shown in Table #2. These sectors can be volatile at inflection points.

Table #2: Sector Performance by Business Cycle Stage

The following chart from The Business Cycle Approach to Asset Allocation by Fidelity Investments quantifies how stocks, bonds, and cash perform compared to a typical portfolio of 50% stocks, 40% bonds, and 10% cash since 1950. The green bar is the average performance, the blue bar is the median performance and the blue diamond (“hit rate”) is the frequency that the asset outperforms the benchmark. Stocks outperform the benchmark portfolio by quite a bit during the Early and Mid-Cycle Stages, but not so much during the late stage. Stocks underperform during a recession.

Figure #2: Asset Class Performance Relative to 50% Stocks/40% Bonds/10%Cash

The Figure #3 from Pring Turner Approach to Business Cycle Investing breaks out the business cycle into three stages (1-3) of contraction and Recovery (4), Middle (5), and Late (6) stages of the business cycle. Their allocation guideline begins with increasing allocations to stocks from 35% at the beginning of the contraction to 65% (buy low) as the recovery starts to gain traction and gradually reducing allocations to stocks to 35% by the late-stage (Sell High) of the business cycle. This is great for tax-advantaged accounts may increase taxes in after-tax accounts. I set my target allocation to 50% stocks, 40% bonds, and 10% cash, tilted to 65% stocks coming out of a bear market and down to 35% as the late-stage progresses.

Figure #3: Asset Allocation by Business Cycle Stage

3.   Model Portfolios at Fidelity

Key Point: I want a “Balanced” portfolio on average that ranges from “Moderate with Income” during a recession to “Growth with Income” during the Recovery Stage.

Figure #4 contains the historical return versus volatility. One has to balance life expectancy, short-term needs, and risk tolerance along with the need to save for retirement and other goals. The chart updated for the next decade or two will look dramatically different because of low-interest rates, end of quantitative easing, high valuations, COVID, and possibly inflation.

Figure #4: Target Asset Mixes Return vs Volatility

There are many investing ideas at Fidelity to help Do-It-Yourselfers, and those trying to decide if or what type of managed account they want. Figure #5 below from Investment Strategy helps investors decide on their allocation. I want a “Balanced” portfolio on average that ranges from “Moderate with Income” during a recession to “Growth with Income” during the Recovery Stage. Bucket #1 for living expenses will be “Short-Term,” Buckets #2 & #3 (Traditional IRAs) are “Moderate”, and Bucket #5 (Fidelity Managed Roth IRA) is currently “Growth”. Model Portfolios for each of these portfolios will be shown in Section 4.

Figure #5: Target Asset Mixes

Figure #6 is more valuable for the detail-oriented investor. While the figure includes the extreme of the 1930’s depression, it does show the potential for a balanced portfolio to have negative returns for a five-year period. I find the lowest five-year return of value. Think in terms of relativity. The “Most Aggressive” Portfolio had the lowest five-year return nearly three times worse than a “Balanced” Portfolio with 50% stocks.

Figure #6: Target Asset Mixes Returns and Drawdowns

I used Portfolio Visualizer to show Fidelity and Vanguard Balanced Funds, along with the S&P 500 (SPY), following the Great Financial Crisis. It took three years to get back to ground level for the balanced funds and five years for the S&P 500. The balanced funds had drawdowns of 32 to 40% while the S&P 500 fell over 50%. These are buying opportunities as long as the investor has funds available and fortitude. I believe that a conservative approach will outperform an aggressive approach over the next five to ten years.

Figure #7: Balance Fund Performance vs S&P 500 During the 2008 Recession

Fidelity Fund Portfolios—Diversified has model portfolios for each of these asset allocations such as this one for the Balanced Portfolio. There are also model portfolios for income and defensive equity.

Table #3: Fidelity Balanced Model Portfolio

4.   Model Portfolios at Fidelity Institutional

Key Point: Insights can be gained into how Fidelity manages portfolios by viewing the model portfolios at Fidelity Institutional.

Fidelity Model Portfolios has links to Target Allocation, Business Cycle, Income, Equity, and Bond Models including Blended and Index Focused Models. Details of the funds in these models, as an example, can be found in Fidelity Target Allocation Blended Model Portfolios Detail as shown below.

Table #4: Fidelity Target Allocation Blended Portfolios

5.   Fidelity Business Cycle Portfolio

Key Point: I elected to use a Fidelity Business Cycle Approach in my Roth IRA although it is very different than the one shown in this section.

Fidelity launched business cycle model portfolios in 2019. This section evaluates a Fidelity Multi-Asset Business Cycle Model Portfolio described on the Fidelity Institutional website.

The team’s current view is that we remain in a mid-cycle economic environment, where equities tend to outperform fixed income. The multi-asset model portfolios remain overweight equities and underweight fixed income. In our view, the U.S. economy and activity levels remain strong…

• Equity allocation in the model portfolios was reduced slightly and exposure to Fixed Income (specifically Investment Grade Bonds and High Yield Bonds) was increased. The roll-off fiscal support, inflationary pressures from supply constraints and a tightening labor market, and moves toward monetary policy normalization contributed to an increased probability of late-cycle…

• The team believes that inflation may continue to surpass expectations and increased exposure to TIPs and Commodities, which tend to perform well in environments where inflation remains elevated or increases faster than expected…

• The replacement of sector strategies with diversified U.S. equity managers reduced the sector-risk contribution to total portfolio active risk.

The benchmark allocation between domestic and international equity will change from 60/40 to 70/30.

Table #5: Fidelity Multi-Asset Business Cycle Model Portfolio

It is not a fair assessment to compare a portfolio with changing allocations to other funds with static allocations. That said, had it had static allocations for the past three years, its performance would have been comparable to the Fidelity Balanced Fund for the past three years which is included as a baseline fund in the table below. MFO Risk classifies it as “Aggressive” (MFO Risk =4).

Table #6: MFO Portfolio Tool with Fidelity Multi-Asset Business Cycle Model Portfolio

Morningstar shows the above business model portfolio to be almost 70 stocks.

Figure #8: Morningstar Analysis of Fidelity Business Cycle Model Portfolio

I will summarize my Fidelity Managed Roth IRA as having 75% stocks with 80% of the funds in three traditional Strategic Advisor Funds (domestic stock, international stock, and bonds) and with 20% in a tactical sleeve including mostly small-cap growth and emerging markets, but also a small allocation to high yield bonds. In the short time that I have had the managed account, Fidelity has only made very small changes once a month.

Closing

I reread in the latest MFO, at the end of David’s introductory letter, and there at the end is the notice of a hiatus for the newsletter. I’m sad to see him step away because he put me onto Brown Advisory and Grandeur Peaks funds which have been stellar performers for me, making up 8% of my portfolio. I hope he does periodically offer thoughts about new ideas. Of course, I’ll keep up my premium subscription.

My Friend, Dave H.

These are my sentiments as well, Dave.

These recent articles summarize my journey to transition from a working person to entering retirement in the near future. As a cancer-free cancer survivor, my primary objective is to have a financial advisor that my wife is familiar and comfortable with. I decided to use the Fidelity Wealth services to manage a portion of my portfolio to maximize risk-adjusted returns. Going through the exercise of writing this article helped me to understand the similarities and differences between how Fidelity and I invest and how to merge them into multi-strategy portfolios.

I have enjoyed writing for Mutual Fund Observer and appreciate the support, ideas, and feedback of the many readers in the discussion boards. You have made me a better investor.

To the Sweet Life – La Dolce Vita!

Fidelity and Vanguard Watchlists and Model Portfolios

I described my Traditional IRAs at Fidelity and Vanguard in Building a Multi-Strategy Portfolio – Vanguard Traditional IRA and Building a Multi-Strategy Portfolio – Fidelity Traditional IRA. I have created watchlists of 100 funds for each of the portfolios based on MFO Composite Ratings, Fund Family Rating, Lipper Overall Ratings, Reamer Ratio, and Ferguson Mega Ratio available in MFO Multi-Search. These represent nearly 200 funds in over 90 Lipper Categories. All of the funds except five have histories more than three years of age. The average Fund Family Rating from MFO is 4.4/5.0. This enables me to spend more time looking at which funds will do well going forward and less time looking for funds.

I built a rating system based on Three Month Returns, Three Month Exponential Moving Average, Ten-Month Exponential Moving Average Trend, and Fund Flows. I also made an attempt to classify the funds according to how they perform during each phase of the business cycle. Below are the top funds by rating, excluding funds that do poorly during the Middle, Late, and Recession stages of the business cycle. In November, in the Vanguard Traditional IRA, I exchanged about a quarter of the Vanguard Commodity Strategy (VCMDX) because it has gained a lot during the past year for the Vanguard Wellington (VWELX) Fund. In the Fidelity traditional IRA, I exchanged the Fidelity Freedom 2020 (FFFDX) for the Fidelity Balanced Fund (FBALX) and consumer staples and utility funds.

Fidelity 100 Trending Funds

Vanguard 100 Trending Funds

Fidelity 100 Watchlist:

ACWV, ANWPX, ARTRX, BAMBX, BMNSX, BOND, BOSOX, CDC, CEMB, COM, CRAAX, CTFAX, CWI, DEVDX, DIVO, DLN, DRSK, EAPCX, EMLP, FADMX, FBALX, FBGRX, FBMPX, FBND, FCOR, FDIS, FDRR, FFFDX, FFXSX, FGILX, FHLC, FIREX, FIVFX, FLPSX, FMSDX, FMSFX, FNCL, FNY, FPBFX, FPXI, FSCOX, FSMEX, FSRRX, FSTA, FSUTX, FTABX, FTBFX, FTEC, FTHRX, FTRNX, FUMBX, FXIFX, GUNR, HEFA, HYLS, IAU, ICSH, ICVT, IHDG, IMCG, INFL, IOO, IWL, IWR, JAGLX, JAGTX, JERTX, JPIB, LABAX, LGMAX, NTSX, NWFFX, PHO, PRBLX, PRESX, PRGSX, PRISX, PRMTX, PRSIX, PRSNX, PTIAX, PZRMX, REMIX, RGI, RSP, RTM, SDG, SMMU, SPSB, SPTI, SPY, SUBYX, SWAN, TAIAX, TIPX, TMSRX, TRRIX, TSIAX, WTCOX, XLRE

Vanguard 100 Watchlist:

ACWF, ACWI, AGZ, ARBIX, BAB, BNDW, BNDX, BSV, CDC, COTZX, CRAZX, DODLX, EMXC, EQWL, ESGV, ETIMX, EXCPX, FIW, GSLC, GTO, HEFA, IAGG, IHI, ISTB, IWL, JHMM, LSWWX, ONEQ, PAAIX, PGLOX, PHDG, QQQ, ROUS, RPGEX, SDG, SPLV, SPSB, SPTI, VAW, VBINX, VBK, VCIT, VCMDX, VCOBX, VCR, VCSH, VDC, VDIGX, VEA, VEMBX, VESGX, VFIIX, VFISX, VFITX, VGCAX, VGHCX, VGIT, VGK, VGSH, VGSTX, VGT, VGWAX, VGYAX, VHT, VIG, VIGI, VIPSX, VMBS, VMLTX, VNQ, VNQI, VOE, VONG, VOO, VOT, VPL, VPU, VSGBX, VSGX, VTC, VTCLX, VTHRX, VTI, VTINX, VTIP, VTMFX, VTV, VTWNX, VV, VWAHX, VWELX, VWIAX, VWIGX, VWITX, VWLTX, VWNDX, VWNFX, VWOB, VWSTX, VZICX

After my friend’s, Dave’s, comment, I extracted top-performing funds at Brown Advisory and Grandeur Peaks to see which might make my Watchlists. The symbols shaded gray are closed to new investors. The links are to articles by David Snowball. There are two emerging market funds of interest that have relatively low exposure to China. The funds are shown in the table below with metrics for six years and ratings for the life of the fund. In order to make my Watchlists, they have to outperform another fund on a risk-adjusted basis without reducing the number of Lipper Categories tracked.

Preliminary Screen Results of Brown Advisory and Grandeur Peaks Funds for further research:

BIAFX, GPEIX, GISYX, GPIIX, BAFWX/BIAWX/BAWAX, GPGIX, GPRIX, GGSYX

 

 

By David Snowball

Each year, usually in our February issue, I walk through my portfolio. It gives some folks the shivers, and others, a nice sense of superiority. On the whole, it seemed like a good idea to accelerate the schedule this year. I’ll walk through it using the same five-part process that we’ve urged on others.

Step One: Assess my goals and resources

My overarching goal is to have a portfolio that I don’t have to pay much attention to (on average, I hold funds for more than a decade), and that doesn’t keep me up at night. That’s the “indolent” part. Beyond that, I’ve had three specific goals in investing and had three distinct portfolios.

1. Retirement: which is unnervingly close. I wanted to be able to leave full-time teaching somewhere between 67 and 70. I’m still really good at what I do, but my department deserves the opportunity to bring in some new blood, and I’d rather leave at a point when folks regretted my departure rather than pray for it.

   Long ago, I did some simple modeling using retirement calculators from Fidelity, TIAA-CREF, and T. Rowe Price. Of them, Price’s Retirement Income Calculator, which runs a Monte Carlo simulation on your behalf, is my favorite. My intentionally modest lifestyle and stable job made aggressive saving possible. If I achieve a 6% rate of return on my portfolio, I end up with a 99% probability of meeting my financial needs for 30 years.

2. Will’s college: he’s a senior now but needs a master’s degree to pursue counseling psychology. While he could go to Augustana tuition-free (a perk of my job), being a student in a small school where your dad is painfully well-known seemed like a recipe for distance. We started a 529 for him when he joined the family at 11 months.

3. Peace of mind: my family was really financially insecure when I was young, which led to hard “groceries or the utility bill” sorts of questions and enormous anxiety. The prospect of ever replaying that degree of uncertainty is more than a little horrifying (note to young parents: childhood trauma is the ghost that stalks adults for decades; raise your children to be joyful and secure), so I want a substantial buffer that’s visible proof that we can handle unhappy surprises. Rather than talk about a “taxable portfolio,” with the implied emphasis on tax efficiency, I think of it in terms of personal independence.

Step Two: Create a strategic plan

By that, we mean figuring out what asset classes I want exposure to and to what degree. Ultimately, three decisions control 90% of your outcome: your asset allocation, your willingness to invest steadily, and your ability to avoid decisions driven by extremes of greed or fear. This is the point at which I tried to make the decisions that most drove the prospect of success.

1. Retirement: 60-75% equities, with a tendency to overweight international, small, quality, and value. Valuations in the US market have been indefensible for a long while, and investors I respect and who have the freedom to choose increasingly choose to be light on the US. I invest 13% of my salary, and my college matches the majority of that.

2. Will’s college: 100% equities tapering down to 0% equity at the point that we began paying tuition. That was Vanguard’s glidepath, and I had no reason to second guess it.

3. Peace of mind: the goal here was consistent real returns, which is to say returns after taxes that exceeded the rate of inflation. Frankly, savings accounts nor CDs promised (guaranteed, locked in) negative real returns when inflation was 1%. As a result, I have very little in a traditional FDIC-insured deposit account.

   The best way to achieve this goal was through a stock-light portfolio. There’s a wealth of research that shows a stock-heavy portfolio is prudent if and only if your goals are decades in the future. For any shorter time period, every additional increment of stock exposure reduces your portfolio’s Sharpe ratio; that is, its risk-adjusted returns. We walked through that research, most recently, in our April 2021 essay, The case for a stock-light portfolio, version 4.0. The bottom line is that from WW2 to the present, a portfolio with just 20% stocks returned 6.8% annually. That translates to receiving about 60% of the returns of an all-equity portfolio with about 25% of the volatility. My portfolio targets 50% growth (half US equities, half not) and 50% stability (half cash-like, half riskier).

   A special note to all you financial planners out there: yes, I know. Over the long run, giving up one-third of your returns can lead to a catastrophic shortfall. But, for portfolios with shorter windows, overexposure to stocks can have the same catastrophic outcomes. (And hugs to you all for the good work you do in trying to make peace of mind and a modicum of financial security possible for many folks.)

Step Three: Create a tactical plan

1. Retirement: I’ve always been held hostage by Augustana’s retirement planning. Originally it was far too expansive – we had access to over 1000 funds and annuities with no guidance and no incentive to save – and now it’s far too restrictive. We’re down to a relative handful of funds with an unhealthy dedication to cap-weight-based passive products. Over the years, we’ve occasionally even been kicked out of funds we’d chosen; once, my largest retirement holding, TIAA-CREF Stock Account, got bounced into the Vanguard 500 fund. Ick.

   Given that, my retirement is now split between a TIAA-CREF administered account and a T. Rowe Price one to which I can no longer add. In each case, I’ve chosen to place 80% of my account in a target-date retirement fund then use other available funds to add exposure to emerging markets and, in particular, EM value equity. I balance the added volatility with small investments in market-neutral funds.

2. Will’s college: We picked a simple age-based allocation using Vanguard funds through College Savings Iowa. Back when Ed Studzinski was co-managing Oakmark Equity & Income, we opened a separate college savings account in his fund. I contributed $100 a month while his mom, whose income was higher beta than mine, occasionally added larger chunks.

3. Peace of mind: here’s the lineup.
   

   	YTD return	5-year return	Weight
   FPA Crescent	15.2%	9.6	20
   Grandeur Peak Global Micro Cap	16.5	19.0	18
   Seafarer Overseas Growth & Income	-2.3	8.7	17.5
   T. Rowe Price Spectrum Income	2.5	4.8	7.5
   T. Rowe Price Multi Strategy Total Return	-2.4	n/a	7
   Brown Advisory Sustainable Growth	30.3	27%	7
   Matthews Asian Growth & Income	-0.3	8.0	6
   Palm Valley Capital	3.8	n/a	5
   RiverPark Short Term High Yield	1.8	2.0	4
   Cash	0	0	8

   The blue cells denote Great Owl funds.

   The funds on the Growth Team (65%) are FPA Crescent, Grandeur Peak Global Micro Cap, Seafarer Overseas Growth & Income, Brown Advisory Sustainable Growth, Matthews Growth & Income, and Palm Valley Capital.

   The funds on the Stability Team are (35%) T. Rowe Price Spectrum Income, T. Rowe Price Multi Strategy Total Return, RiverPark Short Term High Yield, and “cash,” which is just a TD Ameritrade money market.

   Morningstar classifies my portfolio as “moderately risky” and appropriate to those “who are concerned by volatility but not preoccupied with it.” The portfolio analyzer at MFO Premium models a 16.9% maximum drawdown and annual returns of 13.5%. Year-to-date it has returned about 12%.

   These funds reflect my personal biases. Most of the funds have phenomenally high levels of insider ownership of the fund and, in four cases, of the adviser. Most of the managers have a high level of independence in portfolio construction; they are not narrowly bound to a single niche come hell or high water. Most of them have demonstrated exceptional risk management. All communicate clearly and frequently. And many are a misfit in their Morningstar peer groups which means that their star ratings do not strike me as terribly reliable.

   Two major moves in 2020: I eliminate both my Matthews Asia Total Return (MAINX) and my Grandeur Peak Global Reach (GPROX) positions. Matthews was redeemed to help pay house-related expenses. Grandeur Peak Global Reach was eliminated because it was doing too well (20% annually) and was throwing my entire portfolio out of balance as Growth hit 75% of the portfolio and international stocks outweighed domestic by more than 2:1. The correlation tool at MFO Premium showed a correlation of 95-96 between my two Grandeur Peak funds. I chose to keep the smaller, newer, closed fund in the portfolio.

Step Four: Fund your plan automatically.

All three portfolios are on auto-pilot. 13% per month goes into retirement. $100/month into college savings. About $400/month into security though I’ve reduced the auto-investment into Growth team funds except for Palm Valley Capital (an absolute value small-cap fund that’s 80% cash) and increased it for the Stability funds. The goal is to de-risk my portfolio and move closer to the 50 / 50 target.

I’ve done the same thing with my charitable commitments. I have an automatic monthly contribution to organizations that work to preserve the environment (the Environmental Defense Fund and One Tree Planted), to support under-resourced teachers (Donor’s Choose), to defend individual rights (the ACLU), to support members of my local community (River Bend Food Bank and the Community Foundation of the Great River Bend) and to provide meaningful, reliable information to all (Marketplace.org, Iowa Public Radio, Augustana Public Radio, A Way with Words). The contributions are not huge, but they’re absolutely reliable for the groups involved and don’t require initiative on my part.

Step Five: Go enjoy life.

I’m on it! We had a great garlic harvest this year and planted more in the fall. The house is redolent with the smell of pasta sauce and the sight of seed catalogs. Will and I are scouting grad programs for him. Chip is continuing her doctoral studies with the hope of one day being Chancellor Chip. I got a slew of new books to work through in the months ahead and am working on revising one (Miscommunication in the Workplace) and writing another (a text for my Advertising and Consumer Culture class).

What might you take away from my indolent portfolio? I don’t care about “winning.” I don’t care about “beating the market.” I don’t care about the bootless chase after “upgraded” funds. I don’t care about stars or chart-topping anything. I do rather care about people, you included. I care about my neighbors and my community. I care about the planet we’ve inherited and about the prospect that we can restore it to good health. If I’ve done my planning well, my portfolio will support me in protecting the things I care about. Now, and always.

So far, so good.

My advice is simple: do ye likewise.

By David Snowball

Most funds don’t show up on investors’ radar until they have at least a three-year record, which is also the point at which they receive their inaugural Morningstar rating. That’s a generally sensible, sometimes silly constraint since many funds that have been operating for fewer than three years are actually long-tested strategies managed by highly experienced professionals, which are just coming to market in a new form. Relatively recent examples of such funds include Andrew Foster’s Seafarer Overseas Growth & Income (SFGIX), Rajiv Jain’s GQG Partners Emerging Markets Equity (GQGPX), Abhay Deshpande’s Centerstone Investors (CETAX), and Amit Wadhwaney’s Moerus Worldwide (MOWNX). Collectively, those four managers had overseen more than $100 billion using strategies later embodied in their “too new to be on the radar” funds.

As a result, MFO Premium has a preset screen to allow us to identify funds that will receive their three-year recognition within the next 12 months. While many of those are undistinguished, and we’re looking closely at just a handful, our performance and risk screens highlighted a handful of funds that are intriguing.

The big picture is that there were 405 funds, CEFs and ETFs, as of 11/30/2021, which have passed their second birthdays but haven’t yet reached their third. About 200 mutual funds and 200 ETFs. We then sorted everyone by Lipper category, returns versus peers, MFO rating, Sharpe rating, and Ulcer Index rating. Thirty-one of the 405 funds decisively outperformed their peers in both total returns and all three measures of risk-adjusted returns.

The Terrific Twos

		Lipper Category	APR	APR vs Peer	MFO Rating	Ulcer Rating	Sharpe Rating
Alger Mid Cap Focus	AFOZX	Mid-Cap Growth	36.3	+13.9	5	1	5
Allspring (formerly Wells Fargo) Special International Small Cap	WICRX	Intl Small / Mid-Cap Value	12.7	+3.5	5	1	5
Baillie Gifford International Smaller Companies (inst. only)	BICKX	Intl SMID Growth	25.9	+7.6	5	1	5
Baird Municipal Bond	BMQIX	Municipal General	7	+3.3	5	1	5
BlackRock China A Opportunities	CHILX	China Region	30.8	+12.9	5	1	5
Cliffwater Corporate Lending	CCLFX	Loan Participation	8.9	+5.0	5	1	5
Direxion Russell 1000 Growth Over Value ETF	RWGV	Active Extension	39.7	+20.7	5	1	5
Federated Hermes Global Equity	FHGIX	Global Multi-Cap Core	16.2	+2.3	5	1	5
Federated Hermes International Developed Equity	HIEIX	Intl Multi-Cap Core	13.7	+3.7	5	1	5
Fidelity Enduring Opportunities	FEOPX	Global Multi-Cap Core	26.2	+10.0	5	1	5
Fidelity Founders	FIFNX	Multi-Cap Growth	28.3	+3.1	5	1	5
Fidelity SAI International SMA Completion (internal to Fido)	FISZX	Intl Multi-Cap Growth	17.6	+5.1	5	1	5
Franklin Templeton Clarion Partners Real Estate Income Inc	CPREX	Real Estate	14.4	+5.4	5	1	5
Fuller & Thaler Behavioral Small-Mid Core Equity	FTSIX	Small-Cap Core	22.4	+4.3	5	1	5
Goldman Sachs Small Cap Growth	GSAJX	Small-Cap Growth	32.1	+6.7	5	1	5
Harbor Overseas	HAOSX	Intl Multi-Cap Core	13.3	+4.6	5	1	5
Innovator Growth-100 Power Buffer ETF – October	NOCT	Options Arbitrage / Strategies	14.8	+3.8	5	1	5
John Hancock International Dynamic Growth	LG-DQJ2	Intl Large Growth	25.3	+11.6	5	1	5
JPMorgan Core Plus Bond ETF	JCPB	Core Plus Bond	5.5	0	5	1	5
Lazard International Quality Growth Portfolio	ICMPX	Intl Multi-Cap Growth	20.6	+3.8	5	1	5
Nicholas Partners Small Cap Growth	NPSGX	Small-Cap Growth	33.1	+11.9	5	1	5
Overlay Shares Core Bond ETF	OVB	Corporate Debt BBB-	5.3	+1.1	5	1	5
Overlay Shares Municipal Bond ETF	OVM	Municipal General	5.5	+1.9	5	1	5
Pacer Trendpilot US Bond ETF	PTBD	Specialty Fixed Income	5.8	+8.1	5	1	5
Prudential PGIM QMA Strategic Alpha International Equity ETF	PQIN	Intl Multi-Cap Value	10.2	+1.6	5	1	5
Reynders McVeigh Core Equity	ESGEX	Multi-Cap Growth	27.2	+2.9	5	1	5
Sierra Tactical Bond	STBJX	High Yield	10	+4.6	5	1	5
Thornburg Summit	TSUMX	Long / Short Equity	16	+7.9	5	1	5
Timothy Plan US Large/Mid Cap Core ETF	TPLC	Mid-Cap Core	16.3	+2.7	5	1	5
Virtus Seix Senior Loan ETF	SEIX	Loan Participation	4.4	+0.9	5	1	5
Wasatch International Select	WGISX	Intl Multi-Cap Growth	18.8	+4.4	5	1	5
William Blair Small-Mid Cap Core	WBCIX	Mid-Cap Value	24	+9.1	5	1	5

Funds that caught our eye

Alger Mid Cap Focus (AFOZX) is the sibling to the $6 billion Alger Small Cap Focus, which is closed to new investors. Both are managed by Amy Zhang, who brought the strategy from her previous stint at Brown Capital Management Small Cap (BCSIX). Morningstar already awarded it full analyst coverage, which is really rare, and a Silver rating. Small Cap Focus had huge gains since her arrival, then crashed in 2021. The Mid Cap fund has crushed both its Morningstar peers and its older sibling since its inception. It’s probably more “pure thrills” than I’d go for, but it has the makings of a very successful, very aggressive growth fund.

Fidelity Founders (FIFNX) targets firms whose founders are still in charge. One wonders if they’ve noticed the same sort of anomaly that gave rise to Low-Priced Stock all those decades ago?

Fidelity Enduring Opportunities Fund (FEOPX) is a global large-cap fund whose eight-person management team is also responsible for their new series of Disruptive funds, such as Disruptive Tech and Disruptive Finance.

Fuller & Thaler Behavioral Small-Mid Core Equity (FTSIX) is the sibling to the five star, Gold-rated, Great Owl, $6 billion Fuller & Thaler Behavioral Small-Cap Equity (FTHAX). The question with any strategy is, “what do you bring that a dozen other folks aren’t already doing?” In F&T’s case, it’s a profound grasp of the mistakes that other people make and a pretty rigorous discipline that lets them make money off the foolishness of other investors.

Harbor Overseas (HAONX) is run by a team from Acadian; that same team has been running global managed volatility funds for European investors.

Wasatch International Select (WGISX) is run by the same three-person team entrusted with the three-star International Growth fund. The goal is to find the 20-40 highest quality growth companies outside of the US. A mix of old and new talent at the helm.

William Blair Small-Mid Cap Core (WBCIX), with a Morningstar Gold analyst rating, has the makings of a star fund – from strategy to management – but is only available to rich people and retirement plans. (sigh)

You should keep an eye on them; they have the prospect of offering real value in the right portfolio.

By David Snowball

Running them, not assessing them.

Morningstar runs a booming, global asset management business. They have $255 billion under management and advisement (as of 9/30/21).

Of that, $50.5 billion are assets under management, primarily through their Managed Portfolios and Institutional Asset Management services.

They also have 116,627 Morningstar.com Premium members and 17,182 Morningstar Direct licensees.

The managed portfolios traditionally used outside, actively managed funds. In 2018, Morningstar decided they could do better and launched their own family of sub-advised mutual funds to use in the service. In doing so, they severed relationships with some of the managers they’d traditionally relied on, either because the managers didn’t fit or weren’t thrilled with the prospect of substantially lower compensation for their services. In covering the launch (“The Morningstar Minute,” 5/2018), we concluded:

I hope the Morningstar funds do brilliantly well. They represent an interesting experiment, and the financial security of a lot of people rests on them. They seem thoughtfully designed, and their emphasis on cost minimization likely serves their investors’ interests. Nonetheless, the “sleeves for star managers” strategy is hard, as illustrated by the manager turnover at, and occasional liquidations of, the Litman Gregory Masters funds. The “masters” at their Smaller Companies fund (since liquidated), for instance, tend to fall from favor pretty quickly; the fund has had 20 masters since launch in 2003, with some teams out within three years.

After three years, the records for the Morningstar funds are unimpressive. Below is a simplified chart assessing each fund. The first data column is its annual performance relative to its peers; Morningstar US Equity, as an example, trails its average peer by 2.3% per year. The remaining columns reflect each fund’s quintile performance (top 20%, second 20%…) for risk-adjusted returns (Sharpe and the Ulcer Index) and volatility (downside, down market, and bear market deviations). The simplest strategy: look for blue cells, avoid red ones.

Preliminary conclusion: with the exception of Morningstar Defensive Bond (an MFO Great Owl fund) and Morningstar Total Return Bond, their funds are mediocre or worse.

And Morningstar US Equity (MSTQX)? 16 managers (Westwood, Wasatch, MFS, Diamond Hill, ClearBridge, and Easterly Partners), 3 years, returns trailing 80-90% of its peers, one star, high risk, zero manager investment.

Lest you think that Lipper or MFO is somehow biased, here is Morningstar’s own assessment of their funds.

If we grabbed a hundred random samples of nine funds each, we would expect to see three-, four-, or five-star funds in the average sample. Morningstar has one. You’d also predict three one- and two-star funds. Morningstar offers five.

Let’s be blunt: if fund ratings are reliable, you would have been much better off picking funds at random than entrusting your money to Morningstar.

There are two useful conclusions

1. All strategies embed assumptions about markets. When the assumptions are wrong, the strategy falters. Most investors assume that stock prices follow earnings: companies that make more see their stock prices rise. True in the long term, often false in the short term. In mid2020, there was a strong inverse correlation between earnings and stock price: companies that earned the most saw prices fall. In the fourth quarter of 2020, small caps with no earnings – pretty much the junkiest slice of the domestic equity market – rose by more than 40%. Failure doesn’t require the managers to be wrong; it just requires them to be out-of-step.

   Some managers are, of course, wrong. A lot. When we set the MFO Premium screener for the worst-case (trailing your peers for 1-, 3-, 5- and 10-year periods with extremely high expenses and intolerable risk), you end up with a list of 20 funds – some with hundreds of millions in assets – that you’d never want to own.

   In crazy markets, the sanest investors are the hardest hit.

   Traditionally markets embraced and then wrung out the crazies on a seven-year cycle. The Fed’s impulse to protect us by propping up markets has likely delayed, but not prevented, the next cataclysmic reckoning.

2. The best informed and best-resourced professionals cannot assemble star portfolios consistently. Morningstar can’t. Litman Gregory couldn’t. FundX can’t, consistently.

   I can’t. In all likelihood, you can’t. So stop obsessing about it.

You can make good decisions which strengthen your financial prospects. We’ve consistently argued that it’s a simple four-step process:

1. Determine your goals and resources. Why are you investing? When will you need the money? Reasonable goals might be having enough ready cash to get by for several months if you had no income, a college savings portfolio that might allow your child to graduate with under $20,000 in debt (depending on who’s calculating it, the average undergraduate college debt is $30,000-40,000 with an average monthly payment of $400 for a decade), or a retirement portfolio that could replace half of your current income.
2. Set up a strategic plan: an allocation that gives you the best chance of getting there. In general, investing more than 50% of your portfolio in risk assets (aka stocks) or more than 0.1% of your portfolio in damned silly trinkets (cryptocurrencies, NTFs, fractional ownership of fine art, blank check SPACs) is a bad idea unless your willingness to stick with a losing investment spans a period of decades. We’re not making this up. There are 300+ stock funds that took more than ten years to recover from their worst stumble.
3. Set up a tactical plan: a limited number of funds and ETFs to bring the strategic plan to life. Our criteria have always been the same: managers who’ve proved themselves across a variety of market conditions, whose strategy makes enough sense that you can explain it to your spouse, a profound risk consciousness, and a deep personal investment in the funds they offer.
4. Fund your plan automatically. The traditional set-aside for retirement was 10% of your income; my college’s consultants claim that any reasonable chance of success requires something closer to 20%. No one will ever do that if it takes an act of will on the 1^st of each month. An automatic investing plan saves you.
5. Go enjoy life. After all, isn’t that the purpose of the money? To make a good life possible, not to become your life. Read a book (15-30 minutes a day thwarts both dementia and depression!). Get in the habit of starting each day with a bit of coffee and a bit of journaling. Say something nice to the first person you see, every day. Spend as much time as humanly possible away from screens and with nature … or friends, pets, children, community.

And when you do, thank Morningstar for helping you think more clearly about it all!