In my former life in the private sector prior to retiring, part of my role was risk mitigation; identifying potential bad things that might happen and minimizing their impact in case they do happen. I have carried that practice into investing. The financial landscape is constantly changing, but these changes are extreme this year. In preparation for the known unknown, I lowered my stock-to-bond allocation from 65% to 55% by changing what I manage. I desired to lower my stock-to-bond ratio even further to 50% within a range of 50% to 60% and was able to do so by changing my profile with my Financial Advisor at Fidelity.

I use Vanguard to manage a portion of my investments and enjoy reading Vanguard Capital Markets Model forecasts for insights about long-term returns. In January of this year, Isabel Wang described Vanguard’s view that investors could get a better risk-return trade-off by adopting a 40/60 portfolio than the traditional 60/40 portfolio, in “Consider flipping your 60/40 portfolio to 40/60 as bonds become more attractive than stocks”. The reason is that stocks are highly valued, which suggests below-average long-term returns, and starting yields are also high, which suggests above-average fixed income returns.

I follow the Bucket Approach artfully described by Christine Benz at Morningstar, recently, in The Bucket Approach to Building a Retirement Portfolio. I consider all my Traditional IRAs, which are managed collectively by Fidelity, Vanguard, and me, to be in the intermediate bucket because of required minimum withdrawals. The stock-to-bond allocation of this bucket is approximately 35% with half in international stocks. I want the intermediate bucket managed for risk-adjusted return.

Another responsibility of mine while working was implementing technology applications. I believe that there are a lot of benefits to artificial intelligence, but it will take more time to implement, require additional costs and resources to implement, and require huge investments in infrastructure. I believe that the domestic start market is overvalued, especially in the information technology sector. The allocation to information technology and communication services in my intermediate bucket is around 25% compared to 40% for the total market.

There you have it. I am a conservative value investor for the most part. Let’s continue with the risk audit.

Combining Tariffs and The Budget Bill

There are major changes happening in tariffs, the budget legislation, and policy changes, and the combined effects of these are unknown. This section focuses on the impacts of these changes. There are other factors as well, such as the impact of deportations on the labor market and the falling value of the dollar.

The Federal Reserve concluded in Trade-offs of Higher U.S. Tariffs: GDP, Revenues, and the Trade Deficit that tariffs can result in significant economic losses for the U.S., China, and the global economy, as much as 2% for the U.S. economy. The Yale Budget Lab estimated in State of U.S. Tariffs: July 7, 2025 that in “the long-run, the US economy is persistently -0.4% smaller.”

Final OBBBA Score Confirms Long Road to Fiscal Recovery by the Committee for a Responsible Federal Budget, estimates that the budget legislation costs $3.4T, as estimated by the Congressional Budget Office, and with interest, may cost $4.1T. The 2025 Budget Reconciliation Act Will Increase Debt While Modestly Boosting The Economy by The Tax Policy Center, estimates that debt as a share of gross domestic product will rise to 127% in 2034, and possibly higher compared to the CBO’s baseline of 117%. Hmmm, 2034 is the year that Social Security benefits will have to be reduced unless Congress acts to resolve the shortfall.

The Tax Foundation wrote Trump Tariffs Threaten to Offset Much of the “Big Beautiful Bill” Tax Cuts, combining potential impacts of both tariffs and the budget bill. They conclude, “Our analysis finds the current US-imposed and scheduled tariffs threaten to offset much of the economic benefits of the tax cuts, while falling short of paying for them.” They estimate that if the tariffs are left in place permanently, they will reduce long-run GDP by 0.5 percent before retaliation.

If tariffs are not passed along to consumers in the form of price increases, then they are absorbed as costs by companies. Zachary Folk at Forbes describes this effect in GM: Tariffs Cost Automaker $1.1 Billion Last Quarter. Shares of General Motors fell 8% upon reporting earnings impacted by tariffs.

Valuation Risk

Figure #1 shows the S&P 500 price-to-earnings ratio for the past 90 years. The current price-to-earnings ratio is 29.5, which is higher than 94% of the past 90 years. In my investment model, as we see later, I composite the S&P 500 price-to-earnings ratio along with market capitalization to gross value added, Tobin’s Q Ratio of market value to replacement value, cyclically adjusted price-to-earnings ratio, S&P 500 dividends to 10-year Treasury yield, and Rule of 20 for inflation. No matter how I slice it, U.S. stocks are highly valued.

Figure #1: S&P 500 PE Ratio – 90 Year Historical Chart

Source: S&P 500 PE Ratio – 90 Year Historical Chart | MacroTrends

Yield Risk

The yield on the US 10-year Treasury rose dramatically during the 1960s and 1970s, as a result of inflation, and fell to extremely low levels following the financial crisis as a result of Quantitative Easing and easy monetary policy. Figure #2 shows the yield on the 10-year Treasury along with the real yield as measured by subtracting the year-over-year changes in the personal consumption expenditures price index.

Since the 1960s, total public debt as a percent of gross domestic product has risen from 40% to 121%. I expect tariffs to increase inflation to 3% or higher in the short term. While I expect short and intermediate yields to fall at the end of the year, rising national debt and inflation could result in periods with higher yields.

Figure #2: Nominal and Real Yield on Ten-Year Treasuries

Source: Author Using St. Louis Federal Reserve FRED Database.

Investment Model

Figure #3 contains the results of my Investment Model (black line) compared to the S&P 500 (red line), T Rowe Price Capital Appreciation (PRWCX, purple line), FPA Crescent (FPACX, green line), and Vanguard Wellington (VWELX, blue line), along with my Valuation Indicator (orange dotted line, right scale) where a minus one indicates the stock market is highly overvalued. Here are my observations, 1) over the past thirty years some actively managed mixed asset funds have performed about as well as the S&P 500, 2) during periods with normal interest rates, mixed asset funds can outperform the S&P 500, and 3) since the financial crisis stocks have outperformed mixed asset funds because Quantitative Easing and easy monetary policy punished bond returns and stocks have become highly valued. Real GDP grew at an average 2.55% annual rate from 1995 through 2012, and 2.4% from 2013 through 2025Q1.

I expect the markets to be more volatile over the coming decade with more frequent bouts of inflation. I expect more conservative allocations will again outperform the S&P 500 on a risk-adjusted basis.

Figure #3: Investment Model Results Compared to Selected Mixed Asset Funds

Source: Author Using St. Louis Federal Reserve FRED Database and MFO Premium fund screener, and Lipper global dataset.

Table #1 shows the funds that I use in my investment model. They were selected based on having good risk-adjusted performance for the past thirty years. I use minimum and maximum allocation constraints for the funds. I update small allocation changes quarterly based on volatility-adjusted three-month returns and valuations. The current allocation seems reasonable. The allocation to money markets may be too high if the Federal Reserve lowers interest rates in September. On the other hand, money market funds are available to buy during market dips.

Table #1: Funds in the Author’s Investment Model – Three-Year Metrics

Source: Author Using MFO Premium fund screener and Lipper global dataset; Morningstar for year-to-date returns as of July 24th.

Figure #4: Funds in the Author’s Investment Model

Source: Author Using MFO Premium fund screener and Lipper global.

Risk Assessment of My Portfolio

With a dual-income household, with assets at two asset managers, in multiple types of accounts, we own a lot of funds, but about 40% is concentrated in ten funds.

Below is my portfolio segmented by MFO Risk Rating and MFO Performance Rating for risk-adjusted returns, excluding about 10% that is mostly in bond ladders. The blue shaded area represents funds that have a higher MFO Performance Rating than Risk Rating. Over half of my funds by allocation fall into this sweet spot. The yellow shaded area has an MFO Performance Rating equal to the MFO Risk rating. I expect these to be mostly passively managed index funds. Nearly a third of my portfolio is allocated to the yellow shaded areas. The red shaded area represents allocations to funds that have a lower risk-adjusted performance rating than the MFO Risk. These are mostly international funds that had below-average risk-adjusted performance over the past three years but have done great year-to-date.

Table #2: MFO Risk and Performance Rating of Author’s Portfolio

Source: Author Using MFO Premium fund screener and Lipper Global.

In summary, my portfolio is well diversified without much in higher-risk funds (MFO Risk = 5). The funds with below-average MFO ratings are mostly money market funds and short-term bond funds, which don’t concern me.

During secular bull markets, it is difficult for an actively managed fund to outperform a good passively managed index fund. I believe that in a secular bear market or even volatile markets, actively managed funds can outperform a passively managed index fund, particularly on a risk-adjusted basis.

Table #3 below shows the percentage of the allocation from actively managed funds. Most funds that outperformed were actively managed (blue shaded area). The equity funds that underperformed included more passively managed funds. Over half of the equity funds managed by Vanguard in my portfolio are actively managed.

Table #3: Percent Actively Managed Funds in Author’s Portfolio

Source: Author Using MFO Premium fund screener and Lipper Global.

Closing

I am currently reading “Our Dollar, Your Problem” by Kenneth Rogoff, which looks at the future of the dollar as the world’s reserve currency and financial stability. Dr. Rogoff was at a lunch in China in 2005 and was asked to say something about the global economy. He described his answer as:

“I pointed to the high level of consumption in the United States, partly financed by consumers borrowing against their homes. Correspondingly, it seemed that the level of consumption in China was extraordinarily low, even by the standards of Asian economies. That was helping to produce a large flow of funds from China to the United States. That inflow, in turn, was contributing to very low interest rates in the United States, not only for the government but also for households, as well as a massive run-up in equity and housing prices. Near term, the risks were greater for the United States.”

Here we are, twenty years later, and low interest rates and massive financial stimulus have again contributed to high equity prices and, more recently, to inflation. I wrote Living Paycheck To Paycheck and the Role of Financial Counselors for the Mutual Fund Observer November 2024 newsletter, in which I described that about a third of Americans are living paycheck to paycheck with no savings, and another third are living paycheck to paycheck without enough savings to cover three months of living expenses. Tariffs are a regressive tax on consumers. Consumers will have to adjust their spending habits as low-cost imports become more expensive.

I skipped to the final three-page chapter of “Our Dollar, Your Problem” to read what Dr. Rogoff views as our potential risks. These include the decline in the dominance of the dollar, “false sense in U.S. political circles (and among many economists) that ultra-low interest rates are almost certainly the future norm”, rapidly rising debt, “sustained period of global financial instability marked by higher average real rates and inflation and more frequent bouts of debt and financial crises”, “another bout of high inflation over the next five to ten is years is not only possible but likely”, and less independence of the Federal Reserve.

I don’t expect an inflationary period like the U.S. experienced from 1966 until 1982. However, in the hundred years prior to 1982, recessions occurred every four years. Since then, recessions have occurred on average every ten years due in part to globalization and rising national debt. My risk assessment warns that my portfolio should be able to withstand more frequent periods of inflation and financial crises. Now is a time for active portfolio management to manage higher risk and to check on our margin of safety.

I’m struck by the near unanimity of Informed Commentary on the direction of the US stock market. People seem to agree that “the magic number” is 15%.

The disagreement comes in the query: but 15% in which direction? There, there’s about a 50/50 split among the people paid to pretend to know the future. Both growth and recession, market melt-up and market meltdown scenarios are broadly represented. “The melt-up in risk assets continues,” saith HSBC, the global bank based in London. Remember that markets spiked about Alan Greenspan’s original warning about “irrational exuberance.”

We’ll offer a snippet to help you understand each side.

Cause for pessimism

…drunk on propaganda, oblivious to the risks ahead, they may soon find out that they are in for a nasty shock.

Pop quiz! “They” in the above quotations refers to:

1. Investors betting on an eternal bull
2. Trump and his advisers
3. Putin and his advisers
4. Americans, confidently relocating to the southern and southwestern US
5. All of the above.

The narrow answer to the question: C.

The passage is the conclusion of Russian journalist Mikhail Zygar’s essay “Russia’s rulers are in for a nasty shock” (NYT, 8/5/2025). The argument is that Putin has decided that America is not worth negotiating with since we keep changing governments (and hence the rules of the game), and so Mr. Trump’s (or, more broadly, the American government’s) disapproval no longer registers: “Russia’s president couldn’t care less.” The oligarchs supporting Mr. Putin believe that sanctions will never be more than window dressing, a nuisance that cannot become serious because Mr. Trump will not risk the attendant oil price spike. Russian propagandists increasingly ridicule the current administration. “This derisive attitude,” Mr. Zygar writes, “betrays how disconnected – and even delusional – Russia’s ruling elite has become.”

At least the survivors are delusional. In the past six weeks, a senior vice president of the world’s largest pipeline company, TransNeft, “jumped” out of his 10^th floor apartment window, the transportation minister shot himself “inside his car” – despite video showing police removing his body from a nearly thicket of bushes – and his 42-year-old deputy died because “his heart stopped.”

The moral of the story: powerful people believe that reality bends to their whims; it does not.

Reality contains a great deal for investors to worry about. Briefly:

1. Warren Buffett, one of our most renowned investors and a guy who counsels never to bet against America, is de facto betting against America. He has been a steady net seller of US equities and now sits on $350 billion in cash. He is joined in his caution by Bill Gross (“Investors, wake up!” X, 7.16.2025), the Apollo Group (valuations on the 10 largest US stocks are more outrageous than in 1999)

2. The Shiller CAPE Index sits at 37.8, the second-highest level recorded. Motley Fool argues that once the CAPE crosses 37, “the index usually declines over the next one, two, and three years.”

3. The best-performing stocks are from the lowest quality companies. At base, speculation is winning. Bespoke Investment Group, in a note to clients, noted that shares of companies that are making no profit have been rising faster than those that are deeply profitable. GMO shared Goldman Sachs data that made the point more broadly.

4. The Trump tax package, hidden behind bluster about imposing “discipline” on government, could add up to $9.1 trillion to the national debt over ten years when including interest costs (Peterson Foundation, 2025).

5. The Trump international goods tax, as currently configured, is projected to reduce US annual GDP by36%. This equates to $108.2 billion or $861 per household per year (Niven Winchester, “New Trump tariffs: early modelling shows most economies lose – the US more than many,” The Conversation, 8/3/2025). The “as currently configured” hedge reflects the fact that expert trackers and legal reviews (e.g., Congressional Research Service, Atlantic Council, Yale Budget Lab) suggest several dozen distinct, formal tariff changes and hundreds of targeted modifications by product, country, or category have occurred since January 2025, often by fiat and with no notice.

6. The Trump international goods tax, concurrently, will cost consumers about $300 billion in 2025. Trump’s tariffs have brought in over $150 billion in 2025 and could reach $300 billion if the current pace persists. Economic analyses show that 75–100% of tariff costs are paid by American businesses and consumers; foreign exporters absorb only a negligible fraction, if any. A corporation’s first impulse has been to try to absorb the cost; General Motors, Ford, Stellantis (Chrysler), Apple, and Procter & Gamble have each taken $1 billion or more in earnings hit this year. The ultimate cost is generally passed to U.S. consumers in the form of higher prices. Procter & Gamble, for example, is set to increase the price of its consumer products – think Tide – by 25% to offset the tariff.

7. The most recent jobs report sucked. Shannon Carroll of Quartz wrote a really sharp analysis of it:

   The July jobs report wasn’t just underwhelming. It may have flipped the story on its head. Payrolls grew by a meagre 73,000 jobs, far below the roughly 110,000 anticipated. Adding insult to injury, May and June were revised down by a staggering 258,000 jobs — the biggest two-month revision in five years— leaving the labor market’s momentum looking weaker than ever. That means payroll growth averaged just 35,000 jobs per month over the last three months, once revisions are accounted for, the weakest stretch since early in the COVID-19 pandemic. That suggests that any job growth in the two earlier post-tariff reports may have been nothing more than a mirage. (Shannon Carroll, The job market’s warning lights are flashing red, Quartz, 8/3/2025)

   There are “no redeeming qualities” to the report, according to “Jeffries analysts” quoted in the story.

The report had two immediate consequences:

1. The stock market evaporated $1.1 trillion. The Dow dropped 1.23%, the S&P 500 by 1.6% and the Nasdaq by 2.24% in a single trading session. The drivers were both the wretched economic report and the latest tariff tirade, “sweeping new tariffs by US President Donald Trump on 68 countries and the European Union, ranging from 10 to 41 per cent” (“Why did the US stock market fall? 3 reasons behind $1.1tn wipe out in single day,” Financial Express, 8/2/2025).
2. President Trump, frothing, fired the Bureau of Labor Statistics official who dared to report the data. In a more-or-less typical move, the president invented unexplained and unproven accusations of “incompetence” and “inaccuracies.” Past BLS directors joined economists in denouncing the move (“Statisticians blast Trump over BLS firing: ‘Dangerous precedent’,” The Hill, 8/2/2025) while Mr. Trump’s appointees rushed to his defense (“White House officials defend Trump’s firing of BLS chief,” MSN.com, 8/3/2025). The credibility of BLS data has been described as “Trump’s $2 trillion gamble,” because there’s a $2 trillion securities market tied to US inflation data. Bloomberg concludes that the effects of a loss of faith in the data would be “catastrophic” (Bloomberg evening briefing, Americas edition, 8/5/2025).

Cause for optimism

This is trickier. I guess there are two bits of guarded optimism.

1. The US is not the world. Only 4% of the world’s population (though a very influential 4%) live in the US, and just under half of them live in “red” states that are feeding the climate-denial / anti-renewable energy fire. Much of the rest of the world is (a) bewildered by us – Chip and I fielded a lot of half-amused questions while in Scandinavia but (b) is moving sensibly forward without us. Maybe we’ll become the New Portugal?

   As of May 2025, all houses in the UK will be legally required to install solar panels by 2027. The goal is to decarbonize the electricity grid by 2030. A new report shows that Paris has cut its emissions in half with simple changes to the city. Over the past few years, Paris has been reconstructing their infrastructure to move towards sustainable transportation. Cities worldwide are cutting emissions, greening streets, and adapting to climate threats faster than national governments. Solar and wind are now the fastest-growing energy sources in history, with global solar capacity doubling in just two years and new projects supplying most of the world’s electricity demand. Solar and wind are now the fastest-growing energy sources in history, with global solar capacity doubling in just two years and new projects supplying most of the world’s electricity demand. Global investment in clean energy is on track to reach a record $2.2 trillion in 2025, according to the International Energy Agency (IEA), which is twice the amount expected for fossil fuels.

   And in most European and Asian countries, national policies seem to reflect a rational assessment of the needs of the people rather than an obsessive concern for a small group of the ultra-rich. That translates, in most instances, to reasonable regulation, reasonable debt covenant requirements, and reasonable profits.

2. Most securities, in most markets, are reasonably priced. Most non-US markets and a wide spectrum of global assets are considered reasonably priced or even undervalued relative to long-term averages. Major asset managers highlight that, outside the US, most developed and emerging market equities are trading near or below historical valuation norms, making them attractive by comparison to the US. Private markets also show a favorable environment for dealmaking thanks to realistic valuations and robust capital supply. Real estate and credit markets outside the US similarly reflect valuations near fair value, with some pockets of undervaluation. In the US, some sectors (notably value, small-cap, energy, and healthcare) trade below fair value or at discounts. There is money to be made, just not where you’ve been making it lately.

3. Claude could save us, aka an AI-Driven Productivity Revolution. While many argue that the “AI revolution” is 90% hype, recent research cited by the St. Louis and Dallas Federal Reserve banks suggests AI could boost productivity growth by 0.3 to 3.0 percentage points annually over the next decade, with a median estimate of 1.5 percentage points. Workers using generative AI reported saving 5.4% of their work hours, suggesting a 1.1% increase in productivity for the entire workforce. This could represent a productivity breakthrough comparable to the IT revolution of the 1990s.

Managing through the uncertainty

In general, both statistical analyses and expert opinion push you in the same direction. In general, the recommendations are:

1. Assume that the market may rise dramatically soon
2. Allow for the prospect that it will then fall dramatically
3. Don’t get greedy; establish a sensible, risk-aware asset allocation and tune out the noise
4. Move away from overpriced assets ‘cause they’re often historically overpriced
5. Move away from a US-centric portfolio
6. Move away from assets that are highly sensitive to changes in federal policy.

In practical terms, consider more weight in bonds and short-term high yield. Consider more weight in gold and real assets. Consider investing in smaller stocks, rather than larger. And don’t write off the emerging markets. That doesn’t mean selling long-held positions; it means getting psychologically prepared for volatility and making shifts in your portfolio to keep your worst-case outcomes manageable.

Vanguard’s balance: In an interview with Shawn Tully, a senior editor at Fortune, Vanguard’s president and CIO, Greg Davis, made these arguments:

1. The bullish case for US equities, driven by Mr. Trump’s wise policies and an AI revolution, is implausible.
2. US stocks are likely to underperform bonds on a risk-adjusted basis over the next decade. That’s because they’re wildly expensive (about 49% overvalued, based on their Shiller Cyclically Adjusted Price-to-Earnings multiple), and earnings for the market as a whole are stagnant. From the end of 2021 to the beginning of 2025, S&P 500 earnings per share rose just 9.6%. Not 9.6% annually. 9.6% total over three years, substantially less than the rise in inflation.
3. Vanguard projects US equities are priced to return between 3.8 – 5.8% annually. The midpoint would be something like 5% a year at a time when you can get 4.3% on cash. International stocks, which start with dramatically lower valuations and fewer political headwinds, are priced to return 7% annually.

Recommendation: a balanced portfolio should be 60% bonds, 20% US equities and 20% international equities. (Shawn Tully, “The investment chief at $10 trillion giant Vanguard says it’s time to pivot away from U.S. stocks,” Fortune, 7/24/2025)

Which, by the way, is pretty much The Indolent Portfolio (50% growth, 50% stability; 50% here, 50% international with a preference for small, cheap, and quality) that we’ve been encouraging you to consider all along. Year-to-date, through 7/30/2025, the portfolio is up 8.4%.

Options for a US-lite addition

We used the MFO Premium screener to identify funds that demonstrated XX important characteristics over the past five years:

1. They had equity-like returns: we looked for 8.0% annually or more.
2. They had a low correlation to the S&P 500: that’s our attempt to build in insulation against US market gyrations and, to an extent, against US tax and tariff policies.
3. They generated some income, which might come from dividends or the interest on bonds.
4. They demonstrated exceptional downside protection: measured by a combination of their Ulcer Index rating (which combines metrics on how far a fund falls and how long it stays down), S&P500 downside capture (which measures how much a fund captures of the S&P’s fall), plus downside and down market deviation (how much “bad” volatility they capture).

Quick snapshots of some of the funds that pass the test.

AQR Diversifying Strategies (QDSNX):

What it does: Allocates to six AQR alternative mutual funds (Managed Futures Strategy, Equity Market Neutral) and seeks to add additional value over time through tactical positioning

Why you might be interested: It has a 0.01 correlation with the S&P 500. That translates to, “nothing that happens in the S&P 500 predicts what this fund will do.” S&P soars, fund shrugs. S&P crashes, fund shrugs. Five-year annual return 12.0%, MFO Great Owl and Morningstar five-star rating. Remarkably low expenses, at 0.44%.

Why you might hesitate: Well, it does kind of layer complexity on top of complexity since the underlying funds are all financial engineering vehicles. And it does have $4.1 billion in AUM already.

First Eagle Global Income Builder (FEBAX)

What it does: They want to generate current income while also providing long-term growth. The equity team is value-oriented and looks for companies they believe to be well-positioned, well-managed, and well-capitalized, and invests in them only when they are trading at a “margin of safety.” They move opportunistically between assets, typically holding 0-55% of their assets in global equities, 30%-40% in corporate and sovereign bonds, 5%-10% in cash, and 5%-10% in gold bullion. It yields about 2.5%

Why you might be interested: It has a five-year correlation of 0.56, which means that the movements in the S&P predict about half of the movements in this fund. About 20% of the portfolio is currently in US equities. It has returned 8.8% annually. Its maximum lifetime drawdown was short and shallow.

Why you might hesitate: The long-term record of the fund is good, but the entire fixed-income team decamped in February 2024. The new team offers us just a 16-month track record.

Hartford Real Asset (HRLAX): 

What it does: The managers seek exposure to inflation-related equities, inflation-linked bonds, and commodities. Currently, that’s 25% US equities, 25% international equities, 40% bonds, and the rest in commodities. Its equity holdings are heavily weighted toward real estate, basic materials, and energy (“real asset” sectors) and, on the whole, smaller and more value-oriented than its peers’.

Why you might be interested: it has a five-year correlation of 0.49 and has returned 9.6% annually. It has a 4.2% dividend yield. It is consciously constructed to take on inflation, which is often a disaster for other sorts of funds. It captures 96% of its Morningstar benchmark’s upside and 75% of its downside. The fund is sub-advised by Wellington Management, which is generally recognized for investment excellence. The expense ratio is 1.25%.

Why you might hesitate: the fund holds $61 million in AUM (which is either good or bad depending on your business model).

Intrepid Income (ICMUX)

What it does: The managers want to create a diversified portfolio of high-yield corporate debt securities, bank debt, convertible debt, and U.S. government securities. Typically, they have a relatively short duration (typically 2-6 years, currently 3.5 years, which makes them pretty interest rate insensitive). They target businesses that are understandable, typically mature, established leaders in their industries, generate consistent cash flows, have strong balance sheets, and are run by strong management teams. They’re pretty obsessive about understanding their issuers because they need to believe that the bonds’ prices are temporarily depressed and that default risk is minimal. They also target smaller bond issuances, under $500 million, because many bond funds are too large to invest in such issues, which increases the prospect of mispricing.

Why you might be interested: a 0.48 correlation to the S&P 500 plus a negative downside capture of -26 against its Morningstar benchmark index, which means that the fund tends to rise when its core-bond benchmark falls. It has returned 8.3% annually over the past five years, has an 8.0% yield, and has done an exceptional job of risk management. Its maximum drawdown over the past five years is 4.9%, 300 basis points less than its peers’. Morningstar rates it as a five-star / Bronze fund.

Why you might hesitate: The fund recently topped $1 billion in assets. When we profiled the fund in 2022, the managers identified $1 billion as about the limit of the strategy’s capacity.

Thornburg Investment Income Builder (TIBAX)

What it does: The managers build a global, diversified multi-asset portfolio of income-producing stocks and bonds that seeks to deliver an attractive and growing income stream. About 25% US stocks, 50% international stocks, and 25% … umm, other stuff.

Why you might be interested: they carry a five-year correlation of 0.61 and have returned 15.7% annually over the past five years. They’ve managed a 5% yield and Morningstar rates them a five-star fund.

Why you might hesitate: $16.3 billion in assets and 75% in equities, which cuts the downside protection. It’s got really strong downside protection for an equity fund, but that still translates to a maximum drawdown of 18.7% over the past five years. That’s good by equity fund standards, but that doesn’t mean it’s automatically good for you. Half of the management team responsible for the fund at the start of 2023 is gone; that’s not a slight on the remaining members or the new guy, but it is a signal that you’d want to think about the changes.

Victory Pioneer Multi-Asset Income (PMFYX)

What it does: The fund seeks high current monthly income relative to the broad market through a diversified portfolio of income-producing stocks and bonds. It has broad geographic diversification – 23% US equities, 21% international equities, 36% in bonds – and asset class diversification, including catastrophe bonds, master limited partnerships, and real estate. The equity holdings tend to be smaller and more value-oriented than their peers. The portfolio is also actively hedged to reduce volatility, while protecting income.

Why you might be interested: The fund has a 0.5 correlation with the S&P 500 and has returned 11.0% annually over the past five years. It has a 6.9% yield, almost double its peers’. MFO recognizes it as a Great Owl fund, and Morningstar assigns it five stars.

Why you might hesitate: This is an $8.3 billion fund, and lead manager Marco Pirondini recently added the responsibilities of Chief Investment Officer for the firm to his portfolio. Those responsibilities, plus some turnover in the management team, give Morningstar pause.

Bottom line

Be careful. Don’t be afraid. Don’t drift into the rocks. Make reasonable, thoughtful changes that align with your needs and risk tolerance, then get back to the things that make life worth living. Good books. Good friends. Gardens. Helping others. Forgiving yourself.

Cheers!

My strategy involves looking at what is trending according to my rating system, and buying what fits into my portfolio if I can build a storyline behind it. My rating system of nearly a thousand funds is based mostly on data from Mutual Fund Observer to reflect my assessment of short and intermediate-term trends. I selected the funds using MFO Family ratings, assets under management, risk, and risk-adjusted performance, and availability without loads and transaction fees through Fidelity and Vanguard.

From the S&P 500 PE Ratio – 90 Year Historical Chart by Macrotrends, I estimate that the price-to-earnings ratio today is at the highest 94% since 1929 and is highly valued. My concern is that high deficits, rising national debt, tariffs, falling dollar, sudden cuts to Federal employment and spending, and uncertainty may create shocks to the economy over the coming years. My rating system is tilted toward equity value and bond quality. 

Ratings for equity, bonds, mixed assets, and “other” are calculated separately and combined into a single rating system with 100 being the highest and zero being the lowest. All four groupings include three-year performance (return and risk-adjusted return), short-term momentum (YTD returns, moving averages, and fund flow), and risk (drawdown, Ulcer Index, and downside deviation). In addition, equity includes valuation (price-to-earnings, price-to-book), bonds include quality (bond rating, effective duration), and yield (including risk-adjusted yield), and mixed-asset includes both valuation, quality, and yield.

The funds selected for this article have a rating of 90 or higher. The list was pared down to one or two per Lipper Category. This article focuses on individual funds, whereas previous articles focused on best best-performing Lipper Categories as a whole.

Lower Risk Funds

The highest rated lower risk funds are mostly in the short-term bond Lipper categories with higher quality, along with inflation-protected bonds. I own iShares Short Duration Bond ETF (NEAR) for its safety. About 7% of my bond portfolio is invested in inflation-protected bonds, although I do not own IGHG. I plan to invest more in inflation-protected bond ETFs with target maturities to add to rungs in bond ladders.

Table #1: Trending Lower Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset; Morningstar for year-to-date returns as of July 24th.

Figure #1 is the yield curve for Treasuries. Long-term rates have risen while short- and intermediate-term rates are falling. I interpret this to mean that investors believe the economy is slowing and rates will fall by the end of the year, but long-term rates are rising on the expectation that higher rates will be required to finance the growing deficit and national debt, along with the potential for higher inflation. I favor bond funds with effective durations in the one-to-five-year range.

Figure #1: Treasury Yield Curve

Source: Author Using St. Louis Federal Reserve FRED Database.

Eaton Vance Global Macro Absolute Return is certainly worth taking a look at. During its eighteen-year life, it has had a 3.8% return with a maximum drawdown of 7.2%. It has an MFO Risk Rating of “2” for conservative and an MFO Rating of “5” for being in the highest quintile for risk-adjusted return for the category.

Likewise, JPMorgan International Bond Opportunities (JPIB) also has an MFO Risk Rating of “2” for conservative and an MFO Rating of “5”. I have diversified global portfolios managed in part by Fidelity and Vanguard, which own international bond funds. I am in the preliminary stage of determining if I want to buy international bond funds in self-managed portfolios.

Figure #2: Trending Lower Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset.

Moderate Risk Funds

I wrote Investing Internationally for the Timid Investor in the June MFO newsletter about Vanguard Global Wellesley Income Fund (VGWIX), which I own. I have some dry powder in a Bucket #3 long-term account and am considering the more aggressive Vanguard Global Wellington Admiral (VGWAX) to complement Vanguard Global Wellesley Income Fund. All three flexible portfolios in Table #2 have similar performance over the past seven years, with Victory Pioneer Multi-Asset Income (PMAIX) and First Eagle Global (SGENX) outperforming VGWAX year-to-date. SGENX is the most tax-efficient of the three.

Table #2: Trending Moderate Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset; Morningstar for year-to-date returns as of July 24th.

Figure #3: Trending Moderate Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset.

Higher Risk Funds

International and global equity funds have done extremely well this year, in part because of their lower valuations compared to the highly valued domestic market. I consider my allocation to stocks to be appropriate, and I am not looking to add any more. The one equity fund that I purchased recently is Aegis Value (AVALX), and I expect to add to that position over the coming years.

Table #3: Trending Domestic Higher Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset; Morningstar for year-to-date returns as of July 24th.

David Snowball wrote about Aegis Value (AVALX) in the MFO July Newsletter, Aegis Value Fund (AVALX), and I purchased some for my younger self. I stopped buying individual securities decades ago, although I always liked small-cap value stocks. It is listed as a Small-Cap Value Lipper Category, but only has 26% invested in the United States and 50% invested in Canada. I bought AVALX as a long-term holding and may add to it over the next year or two.

Figure #4: Trending Domestic Higher Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset.

With the guidance of Fidelity and Vanguard, I was well-positioned with global and international equity funds at the beginning of the year. My final list of highest rated global and international equity funds is shown in Table #4.

Table #4: Trending Global and International Higher Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset; Morningstar for year-to-date returns as of July 24th.

Figure #5: Trending Global and International Higher Risk Funds

Source: Author Using MFO Premium fund screener and Lipper global dataset.

Closing

I analyze trends monthly, looking for opportunities to sell what is not working in order to buy what is trending. I make small changes when appropriate. I pay attention to the changes that Fidelity is making in my managed accounts. Recently, they have made some small defensive changes, including reductions of both domestic and international stock funds, and added bond and alternative funds. This gives me a sense of comfort.

In December 2020, Chuck Akre (1941 – today) stepped away from managing the Akre Focus fund, though he remains chairman of Akre Capital Management. During much of his 50+ year investing career, he built an unassailable reputation for discipline, independence, and excellence. The core of his investment strategy was captured by “the three-legged stool.” He looked for (1) extraordinary business, (2) talented management, and (3) great reinvestment opportunities and histories. His goal was to provide above-average returns with below-average risk, and he was pretty sure he’d found a strategy to achieve that:

It just so happens that [the stock market’s average annual return of 9-10%] correlates with the rate of return on the owner’s capital and frequently with the growth in the book value per share of the typical U.S. company. We posited from this observation that our return on an asset would therefore approximate the return on the owner’s capital, absent any distributions, and assuming a constant valuation. And since our stated goal is to compound our clients’ (partners’ and shareholders’) capital at an above average rate while incurring a below average level of risk, we needed to identify this group of superior businesses which earn above average rates of return on their owner’s capital.

Like Ralph Wanger and other giants of their generation, investors chose to invest in Akre Focus and his earlier charges because of Chuck Akre. Their faith in him gave them strength to hold during turbulent times; his strength gave them occasion to celebrate during good ones.

Mr. Akre handed over the reins in 2020 to John Neff. Mr. Neff joined Akre Capital Management in 2009 as an analyst, became Mr. Akre’s co-manager in August 2014, and succeeded him as lead (now sole) manager on the fund at the end of 2020. Mr. Neff holds a degree in English from Colgate and an MBA from the University of Chicago.

After seeing modest fund outflows in the years since Mr. Akre’s departure from the fund, Mr. Neff and his team made a bold business decision. They have put a proposal in front of shareholders to convert the fund into an actively managed, transparent ETF. If, on September 19, the shareholders endorse the change, the conversion will occur in late October 2025.

We approached Mr. Neff with two questions: (1) What’s up? And (2) what’s next?

What’s up

That is “why become an ETF?” Mr. Neff was blunt: “There is nothing level about the playing field between traditional open-end funds and exchange-traded funds.” Traditional funds bear expenses that ETFs are spared. The tax code imposes different tax treatment on the two, so that fund shareholders are taxed on “unrealized” capital gains – that is, capital gains generated by the manager’s sales rather than by the shareholder’s sales. If a manager is forced to sell shares, either because the quality of the investment changed or because they needed to raise cash, shareholders are on the hook for taxable gains. With an ETF, that’s not the case. For Akre shareholders, that’s a substantial issue since the fund has assets of $12.35 billion but a cost-basis of just $4.55 billion. That is, about $8 billion of the fund’s assets are capital gains.

Beyond unequal tax treatment, distributors such as Schwab “tax” funds through the imposition of fees that lead the fund to levy 12(b)1 fees. At least until tax law and Schwab’s practices change, Mr. Neff anticipates that shareholders will see lower expenses and lower taxes following the conversion.

What’s next?

The discipline lives on. Mr. Neff notes, “We are true believers in the three-legged stool that Chuck laid down in 1989. It works over time even though it doesn’t work all the time. The discipline is easy to describe but unbelievably discriminating in practice. Few firms meet our standards, and opportunities to buy those firms at rational prices are few and far between. So, we wait.” In the case of his most recent acquisition, that wait was almost four years.

Those claims are buttressed by the fund’s Active Share (96.69, which is extremely high) and its portfolio turnover ratio (5%, which is extremely low). The list of “serious” candidates for acquisition by the fund is only 8 – 12 names long.

We also asked, “Who, beyond yourself, is ready to step into the lead portfolio manager role when the time comes?”

Akre: The Next Generation. Trey Tickner and Andrew Millette were made partners in the firm on January 1, 2025. They support Mr. Neff, and he describes them as “integral to our work.” As a result, he considers them “the next generation” of portfolio leaders. Messrs Akre and Neff were looking for bright people with very specific professional experience: at least two years in investment banking and at least two years in private equity. The stint in investment banking means “they can do financial modeling in their sleep and are used to incredibly hard work.” The private equity piece, by contrast, reflects the fact that “we take a private equity approach to public markets, which implies very different criteria than folks trained narrowly in equity investing.” At base, the private equity people look at the company and its prospects. The equity people look at the stock and are attuned to issues of momentum, volatility, quarterly misses and beats, and analyst downgrades. None of which is material to the Akre discipline.

Bottom Line

John Neff faces the classic challenge of succeeding a legendary manager, but four years into his tenure, he’s proven his commitment to Chuck Akre’s principles while making smart business decisions to enhance shareholder value. The ETF conversion addresses real structural disadvantages that traditional funds face, potentially solving the modest outflow problem while preserving everything that made Akre Focus distinctive. With a deep bench now in place and a clear succession plan, this conversion may mark the successful transition from Chuck Akre’s personal legacy to an enduring institutional one.

Blessed are the forgetful, for they “get the better” even of their blunders. Friedrich Nietzsche, “Our Virtues,” Beyond Good and Evil (1886)

Our summer tradition is to update you on our ruminations and recommendations from three (or five) years ago.  That exercise serves three purposes:

1. It provides a reality check on whether our recommendations for options to consider bear fruit. (Or are bare of fruit.)
2. It provides a reminder of how much chaos you’ve already experienced. If we did a pop quiz (quick: the market three years ago this week was a. crashing, b. flat, c. soaring, d. huh? The best answer is “d” but the historic pattern for 2022 was crash into a bear in spring, soar into a bull in summer, crash again in fall.)
3. It provides focus. For me, mostly. Summers are some combination of lazy, hazy, and crazy. The discipline of looking back precisely three years and reassessing our lead story keeps me from spending time obsessively cataloging the types of bees (at least eight species, including two distinct sets of bumblebees) swarming the garden.

In August 2022, we had just been through a stunning market reversal: the S&P 500 fell over 20% coming into June, then jumped 12% in a July-August rally. A second crash and a second rally were in our immediate future. Our lead feature, the Publisher’s Letter, started with a question:

What does this mean for investors?

First, it means you have a choice to make. You need to decide to what degree you believe the optimists – traders think the Fed is about done, FundStrat says “the bottom is in” and we’ve got a 16% upside by year’s end, Morningstar declares that stocks are trading at historically cheap prices – and to what extent you’re willing to bet your financial future that they’re right. If you’re very confident, it’s risk-on time. If you’re not, it’s time for caution. (A warning about letting your guard down: Don’t, August 2022)

Our recommendation flowed from two sets of research.

First, when the market is rising, investors only remember rising markets.

We forget our worst investment mistakes while vividly remembering our successes, with this selective memory being strongest among inexperienced investors who frequently check stock prices. This “motivated forgetting” protects our egos but sets us up to repeat the same costly errors. (King King Li and Kang Rong, “Real-life Investors’ Memory Recall Bias: A Lab-in-the-Field Experiment,” Journal of Behavioral and Experimental Finance, 2023)

This rosy-glasses memory bias creates a distorted view of actual performance, making us more likely to repeat risky behaviors that once paid off while ignoring the hard-learned lessons from our mistakes. (Katrin Gödker, Peiran Jiao, and Paul Smeets. “Investor memory.” The Review of Financial Studies 2025)

We consistently remember our wins as bigger than they were. This inflated self-assessment directly fuels overconfident decision-making in future trades. This memory distortion helps explain why investors keep engaging in wealth-destroying behaviors like excessive trading and poor diversification: we literally can’t remember how badly these strategies worked before. (Daniel J. Walters and Philip M. Fernbach, “Investor memory of past performance is positively biased and predicts overconfidence,” Proceedings of the National Academy of Sciences, 2021)

This memory problem matters because it blinds us to a crucial investment reality that actually does persist: risk. Hence …

Second, returns may be only skin-deep, but risk goes to the bone. There is strong and reliable academic and professional evidence that past volatility predicts future volatility for mutual funds and similar investments. This is in sharp contrast to the widely accepted view that past returns do not reliably predict future performance.

Academic studies show that the standard deviation of a mutual fund’s past returns (its past volatility) is a strong predictor of its future volatility. For example, one large-scale study found that past volatility significantly and positively predicted future volatility for all funds in their sample—meaning that funds with high volatility in the past tend to remain volatile, and low-volatility funds stay relatively stable.

The statistical significance of this relationship is very high. In a comprehensive sample covering over 1,800 mutual funds and two decades of data, the correlation between past and future volatility was consistently positive and highly significant across the board. (see, for example, Feifei Wang, Xuemin Yan and Lingling Zheng, “Should mutual fund investors time volatility?” Financial Analysts Journal, 2021).

Wang, et al conclude that it’s far more profitable to invest based on past volatility than on past returns.

In 2022, we recommended that you might start adding defensive stars to your due diligence list. We commended six funds for your consideration. In particular, ones run by

folks who understand that the surest path to long-term success is avoiding overconfidence and overexposure to risk. They tend to favor high quality businesses purchased at a discount and generally have the ability to scale back equity exposure when things get frothy.

Four of the six went on to post both higher alpha (i.e., excess gains) and lower beta (muted losses) than their peers. One mostly excelled in loss management, and one foundered after losing its founding manager. Here’s the snapshot:

Except for Ariel and Palm Valley, Morningstar rates all of them as either four- or five-star funds (as of 7/30/2025). We cannot recommend Ariel just now. Palm Valley Capital, nominally a small-value equity fund, might best be assigned to the more speculative wing of your fixed-income portfolio, along with global or high-yield bonds. The managers are incredibly disciplined and talented; the problem is that the market has not fallen to valuations that allow them to find many stocks that meet their value + quality criteria. So 70-80% of the portfolio has been invested in short-term bonds and cash, making it a sort of bond fund with a potential upside punch.

For visual learners, here’s the same three-year data, color-coded. In all instances, remember “blue is best, green is good.”

How do you read the table? APR is the annual percentage return over the past three years; the next column compares those returns to its Lipper peers, followed by its Alpha (excess returns) rating, where a blue box means “top 20% of its peer group for this period.”  Since risk is important, we provide a snapshot of five volatility measures (standard deviation, downside or “bad” deviation, volatility in down markets and bear markets, then the depth of the fund’s worst decline). Finally, we combine returns and volatility into three risk-return measures: the fund’s Ulcer Index (which looks at how far a fund falls plus how long it stays down), Sharpe ratio (the most widely used of all risk-return metrics) and the fund’s MFO rating which places greater weight on risk aversion than does the Sharpe rating.

Returns / risks / risk-return balance.  Got it? 

Good!

Much more complete information – more time periods, more metrics, and 10,000 more investments – is available at our sister site, MFO Premium. Folks contributing $120 or more to help support  MFO get a year’s access to MFO Premium.

Bottom line

The US stock market hovers at or near record valuations. It might be that we’ve actually achieved the “permanently high plateau” that Yale economist Irving Fisher foresaw for stocks … in his comments around October 15, 1929.

Or we might have achieved the same state that the market was actually in on October 15, 1929.

I don’t know. Do you? If not, then the advice stands: seek outstanding risk managers who have demonstrated, over time, their willingness and ability to protect you even if it means “leaving money on the table” when markets are high.