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Starting Point

|Includes:ProFunds Bear Fund Inv (BRPIX), PTTAX

Seeking input and advice from others, I've decided to share my portfolio construction and investment decisions for a retirement portfolio with a 20 year horizon before the first cash outflow.  

After being contrarian in 2009 and achieving 100% IRRs due to the purchase in February, March and April  of PGF, Berkshire Hathaway, VWO and other risk assets, I am now preparing for a much less favorable climate.  I have remained fully invested to equities up to now given the long time horizon I have but am starting to raise cash to allow for purchasing at a bargain when a correction comes.  My confidence up to now to be fully invested (again, a contrarian view to investor sentiment) came from two things: a) the healing properties of free markets with virtuous circles of postiive reinforcement (sounds naive but that's the way the economy works) and b) the old adage, "don't fight the Fed".  He who pays the piper calls the tune, and the Fed can pay the piper as much and for as long as it wants. As a student of history, I know what happened in 1937 and Bernanke is even more aware of the consequences of premature tightening.  Having said that, his distant predecessor said that the role of the Fed is to take away the punchbowl before the guests get drunk, and that moment is coming in the next 12-18 months.  Better smart than greedy, therefore, in terms of starting to raise some cash.

Here's my current portfolio construction:

ALLOCATIONS  TARGET %
US Equity   23%
International   19%
Emerging Markets 19%
REIT   26%
VA Reserve   6%
Bonds   4%
Cash   4%
     
  TOTAL   100%

Emerging markets and REIT are managed on a value averaging approach (see William Bernstein's description here www.efficientfrontier.com/va.htm - surprising that a search of Seeking Alpha brings up no reference to it as it makes a great deal of sense in volatile markets) with a value averaging reserve account set up to protect against short-term declines in the two segments (read about VA if this is not clear).  

Unfortunately Value Averaging does not tell you what allocation to start with, it only helps smooth the path to your ultimate terminal value.  I chose high allocations to both Emerging Markets and REIT 6 months ago because a) their volatility should maximize the benefits of VA and b) I felt that REITs were a sector where investor sentiment was lower than other segments and that a healing economy should help boost both confidence and REIT dividends.

Within the segments I generally use low cost index funds since I am a strong believer in the principle that most returns come from asset allocation and also because I'm cheap.  A few exceptions include Yacktman Focused (MUTF:YAFFX) which applies a concentrated value approach and has maintained a generally lower beta style of investing; BRPIX which is a bear fund that I am using as part of the Value Averaging Reserve described above, and Pimco Total Return (MUTF:PTTDX) which gives me comfort to invest in fixed income at a time when capital losses loom. Finally I have a small allocation to Matthews Asia Small Cap (MUTF:MSMLX) which has done very well but which has a 2% fee.

To conclude, I am turning somewhat more cautious given rapidly rising levels of investor sentiment, as well as the historically high valuation levels (but that's rarely stopped the market from rising in the past on a swell of Fed-driven liquidity). Nevertheless with a 20 year time horizon, I can afford to sustain downdrifts, what I can't afford is to be out of the market.



Disclosure: Long all stocks mentioned
Stocks: BRPIX, PTTAX