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December 2015 Performance Review

January 6, 2016

2015 is in the can and it was a year many professional investors will want to forget. Fortunately, there was a rebound late in the year, or the final tally would have been worse. The S&P 500 Index was down slightly but, with dividends, scored a 1.24% total return. Small-cap stock indexes were down 2% to 6% for the year. Bonds were down in price, but with interest payments, a total bond market investor earned just over 0%.

For the month, our Conservative portfolio was down 0.82%. Our Aggressive portfolio was up 0.45%. Benchmark Vanguard funds for December 2015: Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) down 1.59%; Vanguard Total Bond Market Index Fund (VBMFX) down 0.38%; Vanguard Developed Markets Index Fund (VTMGX) down 1.81%; Vanguard Emerging Markets Stock Index (VEIEX) down 2.49%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 1.54%.

For the year, our Aggressive Portfolio managed a market-beating 3.06% return, while our Conservative Portfolio slid 1.36%, largely weighed down by bonds and ill-fated stock funds. There are over 1,000 unique fund of fund mutual funds (funds that own other funds to build a total portfolio like our model portfolio). Nobody that owned stock and bond funds was up more than 3.06% in 2015.

How did our more stock-heavy Aggressive Portfolio beat our Conservative Portfolio in a down year? As it turned out, our own "risky" shorting in gold and oil did far better than the more balanced strategy of a long/short fund in the Conservative Portfolio, Wasatch Long/Short Wasatch Long/Short (FMLSX). And this wasn't the first time Aggressive beat Conservative during a market decline. In the far worse market of 2008, when Vanguard 500 Index Fund Vanguard 500 Index Fund (VFINX) fell just over 37%, our Aggressive Portfolio did slightly better than our Conservative Portfolio.

Thanks in part to bonds and cash, both portfolios fell by less than half of the market's decline in 2008, but the Aggressive Portfolio's controlled downside, even with a larger allocation to stock funds, was due to an allocation to a risky ETF that shorted commodities and took off in 2008. . The so-called long/short or more market-neutral funds we owned in both portfolios mostly helped by not falling. But so what? We did that with cheaper investment-grade bond funds and cash. Why pay a high fee to have a little less downside in a market crash and significantly less upside in a recovery? A good long/short fund would have been shorting things that could have fallen far more than the market (or the long picks) and gone up in 2008 and 2015.

American Century Long-Short Equity AmCent Long-Short Equity (ALHIX) lives on with a new name (AC Alternatives Equity Market Neutral) long after we got out years ago, and the 2.25% five-year annualized return actually puts it in the top 25% of similar funds — which only highlights how lousy professionals are at picking winners and losers. Past holding Nakoma Absolute Return Nakoma Absolute Return (NARFX) disappeared from existence after abysmal returns in the market rebound.

This year our big drag was Wasatch Long/Short Wasatch Long/Short (FMLSX), which somehow managed to turn a roughly flat market into a 16.22% drop — our worst performing fund for 2015. The managers believed a big energy stock allocation was a great way to turn Fed money-printing-induced-inflation into profits, presumably as all the wonderful oil in the ground would inflate in value. This popular investment delusion was why we did the opposite and were short in oil and heavy in longer-term investment grade bonds in our Aggressive Portfolio.

We noted repeatedly how lousy this fund was doing, but kept it for lack of low-cost long/short fund choices and little benefit to cash and more bonds. The better choices were in our own Aggressive Portfolio, where our shorts Gold Short (DZZ) and PowerShares DB Crude Oil Dble Short (DTO) delivered 17% and 96% returns respectively, the latter being the No. 2 (and just shy of No. 1) ETF or mutual fund of the year. We did partially cut the oil short position back early in the year after a major run-up.

Basically, we made money in one portfolio by doing essentially the opposite of what a fund in the other portfolio was doing. Sad but true. Unfortunately, these sort of leveraged inverse ETFs do not make good long-term holdings and are not appropriate for low-risk portfolios — or so the theory goes. These expensive funds require the right entry and exit points (as we learned shorting real estate in 2007-2009). That said, a "good idea" risky short is better than a more conservative diversified "bad idea" short.

The best areas to be in 2015 were Japan stocks — essentially the only fund category to gain double digits, and health care, up 8%. We got out of health care too early but still are benefiting from health care- and tech-heavy funds like PRIMECAP Odyssey Growth (POGRX), up 6.18% in 2015. We're likely going to get out of health care-leaning funds, too, as this party is about over. Muni bonds were the next best area — especially higher-risk munis (in contrast with higher-risk taxable bonds, which were down for the year).

The very worst areas of 2015 included energy and natural resources, and resource-related emerging markets like Latin America — fund categories that were all down over 20% for the year. Emerging markets in general were down about 14% for the year. This hurt our holding in Wasatch Frontier Emerg Sm Count (WAFMX), down about the same with a 12.1% slide, as well as iShares MSCI BRIC Index (BKF), with a 14.06% drop for the year.

While we didn't get stung by the 4%-plus drop in junk bonds, we did lose in the 4-5% range in our longer-term bond funds Vanguard Extended Duration Treasury (EDV) and Vanguard Long-Term Bond Index ETF (BLV) in 2015. This is the other reason our Conservative Portfolio had a down year. Utilities were down almost 10% — a bit more than their interest rate sensitivity should lead to. We just sold out of utility funds in mid-March, which was a little too late.

Bottom line, it wasn't a good year for diversifying. It was a bad year for yield, notably risky yield. It was a far worse year for anything alternative or a little too clever, which is why hundreds of hedge funds have closed lately. Our best moves were going against the popular ideas, as is often the case when markets get rocky. Our poorly performing ideas were too popular, like buying foreign stocks on weakness, or relying on somebody else's ability to pick winning and losing areas. Once again, we were more likely to lose in popular funds.

In hindsight, shorting commodities was obvious. It was not an easy strategy to put into place without actually shorting popular ETFs directly (which we don't do in these portfolios). Mutual funds didn't give many ways to short commodities, just dozens of ways to own them. One fund we owned in client accounts, PIMCO CommoditiesPLUS Short Strategy, a reasonable fee fund that shorted commodity indexes with futures and invested the collateral in bonds, was closed in 2014 for lack of interest just before shorting commodities was a great idea again, like in 2008. Too bad. It would have been a top mutual fund in 2015. PIMCO kept the popular CommoditiesPLUS Strategy Fund open, naturally, which scored a negative 28.24% return in 2015, following a 24.83% loss in 2014.

Stock Funds1mo %
PowerShares DB Crude Oil Dble Short (DTO)27.87%
Gold Short (DZZ)0.91%
Wasatch Frontier Emerg Sm Count (WAFMX)0.54%
PRIMECAP Odyssey Growth (POGRX)0.51%
Vanguard Telecom Services ETF (VOX)-0.38%
Artisan Global Equity (ARTHX)-1.05%
[Benchmark] Vanguard 500 Index (VFINX)-1.59%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.81%
Vanguard Europe Pacific ETF (VEA)-2.15%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.49%
Vanguard MegaCap Growth (MGK)-2.49%
Vanguard European ETF (VGK)-2.63%
iShares MSCI BRIC Index (BKF)-3.47%
Satuit Capital Micro Cap (SATMX)-5.14%
Wasatch Long/Short (FMLSX)-5.65%
Bond Funds1mo %
SPDR Barclays Intl. Treasury (BWX)1.18%
Vanguard Mortgage-Backed Securities (VMBS)0.11%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.38%
Vanguard Extended Duration Treasury (EDV)-0.75%
Vanguard Long-Term Bond Index ETF (BLV)-1.17%