According to the National Bureau of Economic Research, the U.S. economy entered a recession in February of this year. The S&P 500 is down about 5 percent for both the week and year to date. I don't believe that the full impact of the slowdown or continuing risk of COVID-19 is fully priced into the markets. There are plenty of potential disruptions in the near term including the political rhetoric associated with the election. This article describes a conservative investment approach using Mutual Fund Observer to measure risk (Ulcer Index) and Risk Adjusted Return (Martin Ratio) using the author's Ranking System.
Chart #1: S&P 500 Late Stage of the Business Cycle Performance (Volatility)
Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion. – Jesse Livermore
I use an Investment Model as shown below to determine how much risk to take in investments following the philosophy of Howard Marks. The solid blue line is a theoretical stock to bond allocation with a minimum allocation of 20% along the guidelines of Benjamin Graham (who used a minimum allocation of 25%). The Model started to show improvement in late 2019 prior to the impact of COVID-19 on the markets. The red line shows the percent of the indicators that are negative and the downturn in the economy is wide spread.
Chart #2: Investment Model
Source: Created by the Author
Chart #3 shows the total return performance of the S&P 500 (green), Vanguard Wellington (red) which represents a traditional 60/40 stock to bond allocation, the Vanguard Wellesley (blue) which is a more conservative 40/60 stock to bond allocation, and the Fidelity Japan Fund (orange) for the past 22 years. For someone nearing retirement, this time period represents an approximate average life expectancy for a 65 year old. I expect a conservative allocation to perform as well or better than more aggressive allocations over the next decade or two due to slower population growth, aging population, current recession, and high debt and deficits, among other reasons. Much of the gain over the past decade is the result of quantitative easing. I show the Fidelity Japan Fund as a market which has had similar problems.
Chart #3: Twenty Year Baseline Fund Performance
Source: Portfolio Visualizer
Table #1 shows the performance for the base line funds in the previous chart. As someone nearing retirement, managing risk is more important than higher returns. The Sortino Ratio which measures the risk free return divided by the downside deviation is one measure of risk-adjusted returns. As shown below, when adjusted for risk, the Vanguard Wellesley Income Fund has had the highest return compared to the risk taken.
Table #1: Fund Performance since 1998
Portfolio | Return | Max. Drawdown | Sortino Ratio |
Vanguard Wellesley | 7.0% | -18.8% | 1.3 |
Vanguard Wellington | 7.7% | -32.5% | 0.9 |
Fidelity Japan | 4.7% | -63.8% | 0.4 |
Vanguard 500 | 7.1% | -51.0% | 0.6 |
Source: Portfolio Visualizer
I have been using Mutual Fund Observer Premium Services for the past year or two to build risk adjusted portfolios in my own accounts. Earlier this year, I built three model portfolios to use as guidance to build low turnover portfolios that I would be content to hold through recessions with few adjustments. The two year return of these portfolios are shown as red triangles compared to the risk taken as measured by the Ulcer Index which measures the depth and length of drawdowns. The blue circles are baseline funds. A small account is held in a Charles Schwab Intelligent Portfolio which is a Robo-Adviser account. Schwab makes periodic adjustments to these portfolios so it is not a fair comparison to say the Intelligent Portfolio would have been static for the past two years. I used two years because it is the age of the youngest fund in my portfolios. The Fidelity Conservative and Moderate Portfolios are higher performers on a risk adjusted basis.
Chart #4: Return vs Risk (Two Years)
Source: Created by the Author Using Mutual Fund Observer
The Model Portfolios are shown in Table #2 for the past two years along with the performance year to date. The green shaded funds good baseline funds. The blue shaded funds are lower risk funds that I included in a new "Very Conservative" portfolio. I just created it with funds that I want available within 2 or 3 years. Martin Ratio is my preferred measure of risk adjusted returns. APR refers to the average annual return over the past two years.
For anyone interested in the funds and allocations in the model portfolios they are available in this Excel spreadsheet, Seeking_Alpha_May_2020_Portfolios.
Table #2: Baseline Funds and Model Portfolio Performance (2 Years & YTD).
Source: Created by the Author Using Mutual Fund Observer
Each month, I download about a thousand mutual funds, exchange trade funds, and closed end funds available to individual investors through Charles Schwab, Fidelity, and/or Vanguard. I rank these based on risk, return, momentum, income, and quality. Bear refers to the average performance during the past three bear markets. I select the top fund for each of nine buckets as shown in Table #3. These are also available in Seeking_Alpha_May_2020_Portfolios.
Table #3: Top Ranked Categories - 2.5 Years
Source: Created by the Author Using Mutual Fund Observer
Table #4 contains the top ranked funds for each of the top ranked categories above. These are a good place to start to look for funds to add to a portfolio.
Table #4: Top Ranked Funds in Top Categories
Bucket 1: Safety | Vanguard | Fidelity | Schwab | CEF | ETF |
1. U.S. Gov Gen | |||||
2. U.S. Gov Intermediate | |||||
3. U.S. Gov Short-Intermediate | |||||
4. Core Bond | |||||
Bucket 2: 1 to 2 Years | |||||
1. Corp Debt A Rated | |||||
2. U.S. Treasury Gen | |||||
3. Mxd-Ast Target Today | |||||
4. Core Plus Bond | |||||
Bucket 3: 3 to 4 Years | |||||
1. Convertible Securities | |||||
2. Mxd-Ast Target 2020 | |||||
3. Mxd-Ast Target 2025 | |||||
4. Mxd-Ast Trgt Alloc Growth | |||||
Bucket 4: 4 to 5 Years | |||||
1. S&P 500 Index | |||||
2. Telecom | |||||
3. Science & Technology | |||||
4. Health Biotech | |||||
Inflation Resistant | |||||
1. Inflation Protected Bond | |||||
2. Commodities Specialty | |||||
3. Basic Materials | |||||
Yield | |||||
1. U.S. Mortgage | |||||
2. Gen Bond | |||||
3. Corp Debt BBB-Rated | |||||
Global & International Bonds | |||||
1. Global Income | |||||
2. International Income | |||||
3. Emer Mrkts Hard Crncy Debt | |||||
Global & International Equity | |||||
1. Global Large-Cap Value | |||||
2. Global Health Biotech | |||||
3. Global Multi-Cap Growth | |||||
Defensive | |||||
1. Commodities Precious Metals | |||||
2. Alt Equity Market Neutral | |||||
3. Precious Metals Equity |
Source: Created by the Author Using Mutual Fund Observer
Table #5 contains the categories with the highest three month trends. I look for changes in leadership. Currently, I believe that we are in a bear market rally and the funds with the highest three month trend are mostly those that are recovering from the 2020 bear market.
Table #5: Trending Categories
Trending | Rank | Ulcer | MaxDD | Martin | Yield | RTN 3 Months | APR | Bear |
1. Precious Metals Equity | 39 | 10.8 | -24.6 | 1.5 | 2.4 | 25.0 | 17.3 | 7.4 |
2. Mid-Cap Growth | 51 | 6.1 | -20.8 | 2.0 | 0.4 | 8.5 | 13.6 | -22.3 |
3. Science & Technology | 61 | 6.0 | -17.6 | 3.0 | 0.7 | 13.0 | 19.7 | -29.4 |
4. Small-Cap Growth | 32 | 8.1 | -24.5 | 1.1 | 0.6 | 5.2 | 10.0 | -20.0 |
5. Global Small/Mid-Cap | 28 | 7.0 | -23.4 | 0.4 | 3.1 | 2.3 | 4.8 | -27.2 |
6. Absolute Return | 62 | 12.0 | -22.7 | 1.1 | 0.6 | 25.0 | 15.1 | 43.1 |
7. Multi-Cap Growth | 51 | 5.6 | -17.3 | 2.3 | 0.5 | 10.7 | 14.6 | -23.3 |
8. Global Science Technology | 49 | 6.2 | -18.1 | 2.6 | 1.0 | 11.5 | 17.1 | -28.8 |
9. Consumer Services | 53 | 6.2 | -20.4 | 1.7 | 1.2 | 8.2 | 11.6 | -18.4 |
10. Global Multi-Cap Growth | 62 | 5.7 | -17.7 | 2.1 | 0.6 | 9.7 | 13.5 | -20.2 |
11. Global Large-Cap Growth | 39 | 6.0 | -17.8 | 1.7 | 1.0 | 9.1 | 11.3 | -25.8 |
12. Large-Cap Growth | 53 | 5.4 | -16.3 | 2.5 | 0.6 | 10.9 | 15.1 | -22.3 |
13. Telecom | 63 | 5.0 | -15.2 | 2.4 | 1.0 | 9.2 | 13.2 | -23.8 |
14. Sector Equity | 70 | 6.6 | -16.7 | 1.9 | 5.5 | 13.2 | 13.0 | -14.2 |
15. Industrials | 22 | 8.3 | -24.3 | 0.5 | 1.1 | 1.9 | 5.5 | -24.5 |
16. Health Biotech | 53 | 6.4 | -15.6 | 1.8 | 0.8 | 13.7 | 12.7 | -13.2 |
Source: Created by the Author Using Mutual Fund Observer
Due to some changes, I created another Model Portfolio for a Very Conservative Portfolio. It contains funds from a couple accounts that I want available in 1 to 3 years so I want it to be very safe. MFO gives it a Risk Rank of 1 (Very Conservative) for the past two years. Year to date through the end of May, it has returned 1.9 percent.
I was introduced to T. Rowe Price Multi-Strategy Total Return (TMSRX) by David Snowball in his Mutual Fund Observer June 2020 newsletter. I purchased it, Schwab Monthly Income Maximum Payout (SWLRX), Manning & Napier Pro-Blend Conservative Term (EXDAX) funds, money market funds, and short term bond funds for diversification and safety.
Table #6: Very Conservative Portfolio
Very Conservative Portfolio (Two Year Metrics + YTD) | |||||||||
Symbol | Name | Weight | YTD | MAX DD | Ulcer Index | MFO Risk | Martin Ratio | MFO Rating | Yield |
SWVXX | Schwab Value Adv Money | 20 | 0.4 | - | - | 1 | - | - | 1.5 |
SPAXX | Fidelity Gov MM | 18 | 0.3 | - | - | 1 | - | - | 1.2 |
FIKFX | Fidelity Freedom Inc | 15 | 2.1 | (3.1) | 0.9 | 2 | 4.15 | 5 | 1.9 |
FUMBX | Fidelity Short-Term Treasury | 15 | 4.2 | (0.4) | 0.1 | 1 | 25.3 | 5 | 1.7 |
SWLRX | Schwab Monthly Inc Max Payout | 8 | 1.5 | (3.7) | 1 | 2 | 3.48 | 5 | 2.6 |
TMSRX | T Rowe Price Multi-Strat Tot Return | 8 | 3.2 | (4.7) | 1.9 | 2 | 0.61 | 4 | 2.5 |
EXDAX | Manning & Napier Pro-Blend Cons | 8 | 1.8 | (5.9) | 1.5 | 2 | 2.66 | 5 | 1.6 |
SWSBX | Schwab Short-Term Bond | 8 | 3.5 | (0.2) | 0.1 | 1 | 38.9 | 5 | 2.2 |
Portfolio | 100 | 1.9 | (1.2) | 0.3 | 1 | 5.9 | - | 1.8 |
Source: Created by the Author Using Mutual Fund Observer
Always keep a good part of your capital in a cash reserve. Never invest all your funds. – Bernard Baruch
I am cautiously optimistic, but remain conservative until my opinion is confirmed by the markets.
This article was written by
Disclosure: I am/we are long TMSRX, SWLRX, EXDAX. 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.
Additional disclosure: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. I am long all of the funds in the Model Portfolios. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional. In September 2019, I began contributing to the Mutual Fund Observer monthly newsletter.