On December 1, 2000, a passively managed portfolio was created for a non-profit organization as the portfolio had been managed by a local bank. The bank was charging 100 basis points to place the money in three actively managed mutual funds where they were adding another 100 basis points for less than stellar management. 200 basis points for poor management was irresponsible if allowed to continue. After closing out the actively managed funds, the money was placed in a number of index ETFs. Nearly all ETFs were from iShares, as that is what was available back in 2000. The portfolio still holds several ETFs purchased that first year. When Vanguard ETFs became available, many of the iShare ETFs were sold and invested in identical asset classes once represented by iShares ETFs.
Based on Fama-French research, the portfolio was skewed toward value and away from growth. That is still true today, as 21% of U.S. Equities is targeted for value and only 9% for growth. Equal allocations are assigned to large-cap, mid-cap, and small-cap stocks. This is definitely a tilt toward smaller companies than one finds in many portfolios. Initially there were no bonds, commodities, or international real estate ETFs. All three asset classes were added a few years ago after the shock of 2002. Today, a rather substantial 26% of the portfolio is targeted for international markets. Over the past year, that exposure has been a drag on performance.
Asset Allocation Plan: The following Dashboard is from a worksheet housed within the TLH Spreadsheet, the program used to track both portfolio and benchmark performance. The following strategic asset allocation [SAA] plan has not varied much over the last twelve plus years. Other than an occasional rebalancing, few trades are made. There was some shifting in the SAA when commodities, bonds, and international REITs were added to the portfolio.
12-Year Performance: Since early December of 2000 through 19 April 2013, this passively managed portfolio has an Internal Rate of Return of 5.5%. While this is a modest gain, one needs to remember this portfolio endured the technology crash of 2002 and the 2008-early 2009 bear market.
For comparison, the VFINX (S&P 500) index fund had an IRR of 3.6% and the VTSMX (total market) generated an IRR of 4.5% during the same period. These calculations take into account dividends, interest, and cash flow. Many commercial portfolio tracking programs do not accurately account for cash flow when calculating the IRR for benchmarks. The TLH Spreadsheet, when maintained properly, performs this calculation correctly. The TLH Spreadsheet has the capability of generating a customized benchmark for any portfolio. This passively managed portfolio is beating that customized benchmark (ITA Index) by an annual rate of 0.8%.
If I were to make any SAA changes, what might they be? I would likely sell mid-cap and small-cap core holdings, as both are highly correlated with the other U.S. Equity ETFs, particularly large-cap core, VTI. Another change one might make is to switch the target percentages of Developed International Markets (now 11%) with Emerging Markets (now 15%). Another change is to use the percentages from the sale of core holdings to boost Commodities to 5% and increase the allocation of Domestic Real Estate (now 10%).
While the above SAA may be too aggressive for some investors, when passively managed, this well-diversified portfolio has a high probability of outperforming its benchmarks.
Disclosure: I am long VTI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.