Managed Bond Funds Noticeably Strengthen Simple 6 Asset Class Portfolios

by: MyPlanIQ

As the first baby boomers prepare for retirement with the financial meltdown still smoking in our rearview mirrors, we are attempting to build a set of funds that are easy to understand yet have the potential to deliver good returns at a low risk. We have seen that increasing diversification from three areas to six can make a significant impact on simulated historical returns. Sadly, only a few retirement plans (~4%) have six asset classes but we noted that with most of us having jobs in more than one company, it may be possible to create a holistic portfolio with the combination of IRA and 401K or retirement vehicle you use.

In the last article we reviewed historical simulations from a six asset class portfolio and saw that the returns could be more than double what a three asset class portfolio delivered. We are now going to see where we can improve the returns by increasing the number of funds in each of the asset classes. We will do this in a systematic way so the impact can be seen for each addition.

We are going to use a the six asset SIB -- built from one ETF per asset class, It has been pointed out that VEU does in fact include some emerging market stocks so we may be overweighting emerging markets. It is quite possible to substitute VEU for EFA or an ETF or Mutual Fund (HAINX) of your choice and rerun the simulations. For consistency, we are going to stick with VEU.

Asset Class Ticker Name
LARGE BLEND VTI Vanguard Total Stock Market ETF
Foreign Large Blend VEU Vanguard FTSE All-World ex-US ETF
COMMODITIES BROAD BASKET DBC PowerShares DB Commodity Idx Trking Fund
Intermediate-Term Bond BND Vanguard Total Bond Market ETF

The six asset SIB has VTI, VEU, VWO, VNQ, DBC and BND. All of the portfolios have a moderate risk profile -- i.e. 40% of the assets are in fixed income. If you want to see a range of alternatives and their relative performance, MyPlanIQ maintains updated information on major ETFs in most asset classes.

We are going to look at the fixed income portion first for two reasons

  • As fixed income is the largest single element in the portfolio, it is likely to have the biggest impact of all the asset classes -- this is an intuitive conclusion and isn't backed up with any data
  • Fixed income has been under intense pressure of late with many moving the fixed income portion to cash

In another article, when we were attempting to clone the Morningstar 401K plan with ETFs we performed extensive analysis of the ETF fixed income alternatives and we came to the conclusion that nothing could match the performance of the managed fixed income products from companies like PIMCO or Loomis Sayles. I am not going to repeat the exercise here, just to simply say we will add PIMCO Total Return D (PTTDX) Intermediate-Term Bond. We know it is more expensive and less flexible but, in this case, it is worth it.

The Portfolio name has PTTRX in it as that is the fund that is usually found in 401K plans. In this instance we swapped in the retail version PTTDX which is what the simulation uses. PTTDX performs pretty closely to PTTRX but PTTRX does do slightly better. If you have PTTRX in your 401K plan, you are probably already aware of it.

Here are the simulated returns of the original and enhanced Six asset SIBs.

Performance chart (as of Mar 8, 2011)

click to enlarge

Comparison of the 6 Asset Class SIBs with and without Managed Bond Funds

Performance table (as of Mar 8, 2011)

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETF Benchmark With PTTRX Tactical Asset Allocation Moderate 14% 104% 11% 86% 14% 100%
Six Core Asset ETF Benchmark With PTTRX Strategic Asset Allocation Moderate 17% 125% 6% 28% 8% 39%
Six Core Asset ETF Benchmark Tactical Asset Allocation Moderate 13% 118% 9% 73% 13% 89%
Six Core Asset ETF Benchmark Strategic Asset Allocation Moderate 15% 143% 4% 21% 7% 33%

We note that the addition of the managed bond fund gives an additional 1% in returns across the board. That may not sound like much but, over a decade, that will give you an extra 10% in your pocket -- worth having.

It should be pointed out that this calculation does take into account the fees charged by PIMCO but not any transaction charges that may be levied when you come to buy and sell the asset to either reblance or move to cash or the ETF.

One piece of good news is that while 401K plans may not have all the asset classes that could be desired, they often have access to good fixed income choices and so it may well be possible to overweight the fixed income in the 401K to offset some of the other asset classes in the IRA. It is worth checking the performance of the bond funds in your 401K and compare it to PIMCO which in many cases has become the gold standard.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Disclosure: I am long DBC.