We've made significant trades in both of our model portfolios in order to:

1. Reduce our overall stock allocation
2. Rebalance our portfolio
3. Shift from some hotter areas of the stock and bond market into more out-of-favor areas

Broad Goals

Stocks have been going great guns since we hit the bottom of the financial meltdown in March 2009. We generally try to increase our stock allocation on the way down and cut back on stocks as they climb and investors grow more optimistic. 

You can see this strategy in full effect in our Aggressive portfolio since it has more leeway with which to swing stock allocations. Since the mid-2000’s, our overall stock allocation has  been as low as 60% (in 2007, preceding the stock collapse) and as high as 95% (February 2009.)

Our last major trade was in September, 2011 when we used weakness in stocks to up our overall stock allocations by 5% in Aggressive and 1% in Conservative.  September 2011 was a good time to buy as it turns out; the stock market hasn’t been lower than it was during that month since.

We're now taking our stock fund allocation in our Aggressive portfolio back down to 65%. That's a fairly conservative allocation for an aggressive portfolio, but we might go lower if stocks heat up even more within a short time period. If the recent stock slide continues and investors begin selling stock funds again, we may increase our stock allocation. 

We're also making this trade because we need to sell down stocks now that they've increased in value relative to bonds (magnified by the recent hit bonds have taken as rates have risen). Our portfolio uses  real money, which means that a 5% allocation to XYZ fund changes each day, along with the market. In real dollars, the stock allocation in our Aggressive portfolio has recently been as high as 75%+ stock, well above our target allocation of 70%, because the stock funds have fared so well. 

In other words, even if we hadn’t needed to reduce the target stock allocation by five percent, it was time to rebalance the portfolio by selling some stock and buying bonds just to return to its optimal 70% level from earlier this year.

The same applies to the Conservative portfolio, where the real money stock allocation was up to just over 50% recently, well above the portfolio’s 41% stock target. Since our 41% stock allocation is already reasonably low, and stocks are not as overpriced as we've seen in previous booms (so far,) we don’t feel the need to further cut our broad stock allocation at this time. That said, we are adding a new fund that shorts, which will help reduce our stock market downside slightly. 

In our Conservative portfolio, we're also moving into smaller, newer, and more out-of-favor fund categories.

Why rebalance now? Low interest rates are a big reason we didn’t move from stocks to bonds earlier in the year. While stocks were being richly priced (and increasing in popularity,) owning 0% yield cash or a 2% yield bond funds didn’t hold much appeal in a stock market still yielding 2% (a growing dividend yield). As stocks have moved even higher, and bonds have taken a fairly significant hit in recent months, this move makes sense.

Most important to our strategy, investors have been buying stock funds that hold U.S. stocks after years of selling, and have started selling bond funds after years of buying. As contrarian investors, this is a clear signal to us that it's time to increase our overall debt allocation.

This recent dive in bond prices, although it could certainly continue, is already creating good value. Investment-grade, longer-term bonds yield nearly 5%. There's almost no default rate on such bonds. It's an almost pure interest rate bet (although not as pure as longer-term government bonds). 

Since we don’t expect inflation to rise above 2% in the next few years, a real 3% inflation-adjusted return for a safe asset that can lower overall portfolio risk is a good deal, especially since cash yields probably won’t go over 3% any time soon. Keep in mind that interest rates tend to fall in a recession, pushing low default risk investment-grade bond prices up.

We're making this move into longer-duration bonds (a measure of interest sensitivity ) in both our Conservative and Aggressive portfolios. 

Fund-Specific

We're also moving out of some increasingly popular categories that have performed well relative to other categories. These moves are based largely on our MAXcategory rating, which has recently fallen significantly for certain categories. Our category rating focuses primarily on performance and fund flows and downgrades categories that are, or will soon be, popular with investors.

On the stock side, this includes healthcare stocks in our Health Care Select SPDR (XLV) pick, which we've owned since 2005. Value in general is getting relatively expensive, and small and mid-cap stocks are expensive relative to larger cap stocks, which is the basic rationale for most of the domestic stock changes we're making. 

We're sticking with utilities for now, but if they get popular again in coming months, we may cut them loose. Strangely enough, microcap stocks are still reasonably priced, so we’re keeping Satuit Capital Micro Cap (SATMX) and building a barbell portfolio of mostly mega-cap and some micro-cap stocks while avoiding small to mid-cap stocks. Larger-cap stocks are still relatively and even historically well-priced, assuming we don’t get an economic slowdown soon, which we're not expecting.

On the bond side, we're pushing out the duration – meaning we're buying longer-term bonds that yield more but can fall significantly when rates go up, as we saw recently. This is a lonely trade, since everyone expects rates to continue climbing and is determined to avoid longer-term bonds. Vanguard Short-Term Bond Index has $31.5 billion in assets, while Vanguard Long-Term Bond Index has just $5.6 billion.

This interest risk is scary. To put it in perspective, Vanguard Long Term Bond Index (BLV) has a duration of about 14. For every one percentage point rates go up (longer-term rates, not shorter term rates,) this fund should drop 14%. Ouch. So why are we increasing our long-term bond allocation? Because if the economy slows and rates drop again, you could see a very nice offsetting gain to the likely stock decline.

Japan has become a hot speculative area – too speculative for us, so we're going to sit out for now and sell all of our shares of iShares MSCI Japan Index (EWJ).

PIMCO’s newish actively-managed Total Return bond ETF, (conveniently, the ticker symbol is BOND) will benefit from its relatively small size compared to giant PIMCO bond funds The risk here is that current outflows to bonds in general could intensify, causing bonds to fall even more, particularly those owned by ETFs, which are more prone to hot money.

PIMCO Mortgage Opportunities D (PMZDX), also small and newish, is benefiting from its  relatively small size (for a PIMCO fund at least). We also see a bit of a short-term boost from inflows pushing up the price of bonds in the portfolio as the manager buys more.

DoubleLine Floating Rate N (DLFRX) is a new, smaller fund from DoubleLine, a fund family that's gotten a little too popular recently. It does carry a higher credit risk (the risk we're generally trying to avoid right now,) because most floating-rate funds are essentially adjustable-rate junk bond funds. We don’t expect these types of bonds to outperform in general, but this specific fund’s massive inflows combined with investor enthusiasm for floating-rate debt could push up prices in coming months.

It might seem strange that we're buying both BOND and DLFRX, since our overall strategy is to buy out-of-favor funds and categories. Yet in these particular cases, we're trying to get ahead of massive investor inflows that push up fund prices. We don't expect to own DLFRX as long as we typically own a bond fund around here – perhaps one or two years, not three to five. 

As  for BOND? Even if it gets too big, it won't be any worse than other good PIMCO funds, and as it doesn’t focus on floating-rate bank loans (which we consider a questionable longer-term strategy), we may keep it longer. If rates go much higher and these funds outperform our longer-duration bond funds, we may sell them and add more to BLV. In general, it's difficult to find a small, inexpensive bond fund that invests in less popular areas in the bond market, and historically, our bond fund holdings tend to be larger than our stock funds.

With an expense ratio of 1.50%, Artisan Global Equity (ARTHX) is expensive to own, but while it's still small and outperforming, it's a good deal. We'll likely sell this fund when assets rise, because the small-fund advantage it currently enjoys will dissipate compared to larger, cheaper funds.

We're also buying Wasatch Long/Short (FMLSX), a fund that shorts,  because we believe stocks are a bit overpriced. The problem FMLSX has in common with all funds that short? 95%+ of them underperform most of the time. They're also expensive, and bring less value to a portfolio than money market or bond index funds. But money market funds are yielding zero and bond indexes only about two percent. This fund has done well and has the potential to continue to do well, so we’re going to give it a chance.

We’ve been in financials nearly non-stop since financials tanked in the real estate bubble pop, starting with our buy of the Financials ETF XLF in February 2009. But this category’s outperformance in recent years is telling us to get out. Royce Financial Services Fund (RYFSX) gets sold in this trade. This fund has not only beaten the S&P 500; it's beaten 98% of similar funds over the past three years. We’d call that a pretty good run.

iShares MSCI BRIC Index (BKF) is an emerging market ETF focused on the once-gimmicky and overpriced BRIC (Brazil, Russia, India, and China) opportunities. But yesterday’s over-hyped popular investment themes can be today’s good buys (after the excitement abates, that is). We’re not quite at the bargain-of-your-life level in these stocks (there's still too much money in emerging market funds,) but the relative value is good here as long as investors remain wary (a good combination). Besides, U.S. stocks aren't a great deal compared to foreign markets anymore, not after 5+ years of U.S. outperformance.

PowerShares DB Gold Double Short ETN (DZZ) is quite a risky allocation, but the gold bubble ended in 2011, and on the off chance that interest rates climb and we're wrong on bonds, the price of gold should fall even faster than it has already.

Wasatch Frontier Emerging Small Countries (WAFMX) represents another once-trendy, now out-of-favor category. The same way fund companies put out various types of Internet funds in the late 1990s boom (remember B2B Internet funds?) frontier funds were supposed to be the most emerging of the emerging, because… are China and South Korea really emerging economies anymore? The real action could be in Africa and other solidly un-emerged economies. Often, saleable themes that are popular with investors (Wall Street exists to sell investment ideas, after all) become good ideas only after investors move on.

Redemption Fee Information

We won’t see any issues with short-term redemption fees from this trade, or short-term capital gains taxes, since we've owned all of them for almost two years or longer, but keep an eye on your own purchase history, which could be more recent then ours, and consider altering your trades for your own tax and fee advantage. 

Specifically, funds in our portfolios that have their own short term redemption fees, on top of anything your broker may charge if you did not buy the funds directly from the fund families are:

A redemption fee of 2%/60 in the table above indicates that an investor will be required to pay a 2% fee on shares sold within 60 days.

Notes:

Most brokers charge a fee to sell regular mutual funds (not ETFs) bought without paying a commission (NTF or no transaction fee) if sold within 90 days. Many of our funds are NTF funds that can be traded with no commission by popular brokers like Schwab, TD Ameritrade, and E*Trade. Most of our ETFs can be purchased for no transaction fee at TD Ameritrade.

We own many of the above listed funds and ETFs in client accounts at MAXadvisor Private Management and may buy or sell them at any time.

Those with larger portfolios should consider the lower-fee, higher-minimum classes of some of these mutual funds. Our model portfolios are designed to be built with a total investment of less than $100,000. To make this possible we tend to use lower minimum, no-transaction-fee funds, which can cost slightly more in the longer run to own than higher minimum or transaction fee required classes of funds that we typically use in larger accounts.