Category: Portfolio Strategy

Portfolio Strategy

Don’t let Another Debt Ceiling Dispute Box in your Portfolio

With the threat of hitting the debt ceiling looming at the end of the month, government leaders were able to strike a deal. The debt ceiling is the self-imposed legislative limit on the amount of national debt that can be issued by the Treasury and thus restricts how much the federal government can borrow. Treasury Secretary Mnuchin estimated that the government would be able to meet its obligations until late September before defaulting on its obligations. However, the agreement reached was just a three month extension, so this issue will resurface in December; no doubt leading to another protracted battle.

We have been down this road before. Political brinkmanship between the different factions in congress and the administration will no doubt bring increased volatility in the stock market In December. However, we don’t think it would be time to run for the exits. As we have seen with the 2011 and 2013 debt ceiling fights moving a portfolio to cash would of had a negative impact.

In both of those previous instances bonds performed well, showing that in times of uneasiness US government debt remains the ultimate safe haven. The yield on the 10 year Treasury bond has steadily fallen since early July. If there was significant fear that the US would default and not make its debt payments the yield would be rising significantly to compensate investors for holding the bonds.

In portfolio construction, RWM believes the fixed income side of the portfolio should provide stability and capital preservation, while the equity side of the portfolio purses growth.  When volatility spikes on the equity side the fixed income allocation will be there to provide support.

While it certainly can be difficult to remain disciplined to your investment allocation reading the incendiary headlines about the debt ceiling, history has shown those who stay committed to a sound investment allocation are the ones who are likely to realize their long-term investment goals.

 

Index Performance August YTDTrl 1 Yr
US Stock (Russell 3000)0.19%11.20%16.06%
Foreign Stock (FTSE AW ex US)0.50%18.80%19.15%
Total US Bond Mkt. (BarCap Aggregate)0.90%3.64%0.49%
Short US Gov. Bonds (BarCap Gov 1-5 Yr)0.35%1.43%0.45%
Municipal Bonds (BarCap 1-10yr Muni)0.56%4.25%1.22%
Cash (ML 3Month T-Bill)0.09%0.48%0.62%

 

About

Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at www.raffawealth.com

 

There is no guarantee that any investment strategy, including those described here, will be successful. Any investment or investment strategy can lose money. Past performance does not guarantee or predict future results.  You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC.  This information was gathered from reliable sources but we cannot guarantee accuracy.  Indexes do not reflect the fees associated with actual investments and such fees would reduce the performance illustrated.

Don’t call it a Comeback, International Markets have been here for Years

In January we reviewed the topic of international diversification. With the conclusion of 2016 it had been four straight years that US stocks had outpaced international stocks. We heard from many people why should they continue to hold international stocks? The prospects in Europe looked bleak with the UK leaving the EU, China was a constant source of volatility and Japan posted another year of meager growth and inflation.

Our message was to remain disciplined to an equity strategy diversified globally. There are periods of time when the US outperforms and there are times when international markets outperform. We believed that eventually the recent trend would reverse. There have been multiple decade long periods over the past 110 years when international stocks outperformed and we believed they would eventually be in favor again. When exactly it would occur is unknowable, but if an allocation is not maintained an investor would miss out if there was a sustained rally. Also, with roughly 50% of the world stock market and more than 10,000 companies outside of the US, there is a significant investable universe that you would lose exposure to if only focused on the US.

What have we seen in 2017? A significant reversal in global stock market performance. While US stocks certainly continue to perform well, up almost 11% for the year, international stocks have soared, gaining over 18%. Going back over the past 12 months international stocks have outpaced US stocks by over 3%.

While the recent performance is not a guarantee of future results, it does show the benefits of remaining disciplined to an asset allocation strategy that has set targets to US and foreign stocks. By keeping that broad diversification, the portfolio is set to benefit if either perform well. It also likely reduces the overall volatility of the equity allocation.

We believe that an investor with a long time horizon and a desire for growth from their portfolio is best served by investing globally, and, by avoiding market timing, can best positon themselves to meet their long term investing goals.

 

Index Performance July YTDTrl 1 Yr
US Stock (Russell 3000)1.89%10.99%16.14%
Foreign Stock (FTSE AW ex US)3.54%18.20%19.15%
Total US Bond Mkt. (BarCap Aggregate)0.43%2.71%-0.51%
Short US Gov. Bonds (BarCap Gov 1-5 Yr)0.28%1.08%-0.20%
Municipal Bonds (BarCap 1-10yr Muni)0.68%3.67%0.62%
Cash (ML 3Month T-Bill)0.08%0.31%0.49%

 

About

Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at www.raffawealth.com

 

There is no guarantee that any investment strategy, including those described here, will be successful. Any investment or investment strategy can lose money. Past performance does not guarantee or predict future results.  You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC.  This information was gathered from reliable sources but we cannot guarantee accuracy.  Indexes do not reflect the fees associated with actual investments and such fees would reduce the performance illustrated.

 

Getting What You Don’t Pay For

We have a guest blog post this month from Dimensional Fund Advisors addressing the issues of mutual fund and trading costs and their impact on performance.

Costs matter. Whether you’re buying a car or selecting an investment strategy, the costs you expect to pay are likely to be an important factor in making any major financial decision.  People rely on a lot of different information about costs to help inform these decisions. When you buy a car, for example, the sticker price tells you approximately how much you can expect to pay for the car itself. But the sticker price is only one part of the overall cost of owning a car. Other things like sales tax, the cost of insurance, expected routine maintenance costs, and the potential cost of unexpected repairs are also important to understand. Some of these costs are easily observed, and others are more difficult to assess. Similarly, when investing in mutual funds, different variables need to be considered to evaluate how cost‑effective a strategy may be for a particular investor.

Expense Ratios

Many types of costs lower the net return available to investors. One important cost is the expense ratio. Similar to the sticker price of a car, the expense ratio tells you a lot about what you can expect to pay for an investment strategy. Exhibit 1 helps illustrate why expense ratios are important and shows how hefty expense ratios can impact performance.

Exp Ratios

(Click to enlarge)

*See footnote

This data shows that funds with higher average expense ratios had lower rates of outperformance. For the 15-year period through 2016, only 9% of the highest-cost equity funds outperformed their benchmarks. This data indicates that a high expense ratio is often a challenging hurdle for funds to overcome, especially over longer horizons. From the investor’s point of view, an expense ratio of 0.25% vs. 0.75% means savings of $5,000 per year on a $1 million account. As Exhibit 2 helps to illustrate, those dollars can really add up over longer periods.

Exp Ratio over time

(Click to enlarge)

**See footnote

While the expense ratio is an important piece of information for an investor to evaluate, what matters most when gauging the true cost‑effectiveness of an investment strategy is the “total cost of ownership.” Similar to the car example, total cost of ownership is more holistic than any one figure. It looks at things that are readily observable, like expense ratios, but also at things that are more difficult to assess, like trading costs and tax impact. It is important for investors to be aware of these and other costs and to realize that an expense ratio, while useful, is not an all‑inclusive metric for total cost of ownership.

Trading Costs

For example, while an expense ratio includes the fund’s investment management fee and expenses for fund accounting and shareholder reporting (among other items), it doesn’t include the potentially substantial cost of trading securities within the fund. Overall trading costs are a function of the amount of trading, or turnover, and the cost of each trade. If a manager trades excessively, costs like commissions and the price impact from trading can eat away at returns. Viewed through the lens of our car analogy, this impact is similar to excessively jamming your brakes or accelerating quickly. By regularly demanding immediacy like this when it may not be necessary, the more wear and tear your car is likely to experience and the more fuel you will end up using. These actions can increase your total cost of ownership. Additionally, excessive trading can also lead to negative tax consequences for the fund, which can increase the cost of ownership for investors holding funds in taxable accounts. The best way to try to decrease the impact of trading costs is for funds to avoid trading excessively and pay close attention to effectively minimizing cost per trade. Employing a flexible investment approach that reduces the need for immediacy, thereby enabling opportunistic execution, is one way to potentially help accomplish this goal. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and help reduce the total cost of ownership.

Conclusion

The total cost of ownership of a mutual fund can be difficult to assess and requires a thorough understanding of costs beyond what an expense ratio can tell investors on its own. A good advisor can help investors look beyond any one cost metric and instead evaluate the total cost of ownership of an investment program—and ultimately help clients decide if a given strategy is right for them.

 

 

 

 

*The sample includes funds at the beginning of the 15-year period ending December 31, 2016. Funds are sorted into quartiles within their category based on average expense ratio over the sample period. The chart shows the percentage of winner and loser funds by expense ratio quartile; winners are funds that survived and outperformed their respective Morningstar category benchmark, and losers are funds that either did not survive or did not outperform their respective Morningstar category benchmark. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value, and World Stock. For additional information regarding the Morningstar historical categories, please see “The Morningstar Category Classifications” at morningstardirect.morningstar.com/clientcomm/Morningstar_Categories_US_April_2016.pdf. Index funds and fund-of-funds are excluded from the sample. The return, expense ratio, and turnover for funds with multiple share classes are taken as the asset-weighted average of the individual share class observations. For additional methodology, please refer to Dimensional Fund Advisor’s brochure, The 2017 Mutual Fund Landscape. Past performance is no guarantee of future results.

**For illustrative purposes only and not representative of an actual investment. This hypothetical illustration is intended to show the potential impact of higher expense ratios and does not represent any investor’s actual experience. Assumes a starting account balance of $1,000,000 and a 6% compound annual growth rate less expense ratios of 0.25% and 0.75% applied over a 15-year time horizon. Taxes and other potential costs are not reflected. Actual results may vary significantly. Changing the assumptions would result in different outcomes. For example, the savings and difference between the ending account balances would be lower if the starting investment amount was lower.

There is no guarantee that any investment strategy, including those described here, will be successful. Any investment or investment strategy can lose money. Past performance does not guarantee or predict future results.  You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC.  This information was gathered from reliable sources but we cannot guarantee accuracy.  Indexes do not reflect the fees associated with actual investments and such fees would reduce the performance illustrated.

Combating a Potential Trump Slump

Over the month it became increasingly apparent that the Trump administration may run into several challenges that could hamper its agenda. Markets reacted particularly strong mid month when anonymous sources claimed that the President asked that FBI Chief James Comey end the FBI’s inquiry into Trump’s former national security adviser, Michael Flynn, and his interactions with Russia.  US stocks sank 1.8% when the news broke and foreign stocks sank 1.2%.  Investors grew concerned that a Russia cloud would hang over the administration and greatly slow or bring to a halt the President’s agenda.  If the tax breaks, reduced regulation and increased infrastructure spending that the market has factored into stock prices are delayed, or never materialize, it would likely send US stocks down.

It is anyone’s guess how the various investigations and inquiries play out, but there will likely be significant volatility over the coming months as new stories break. How much the President is slowed and what actually gets passed will have a significant impact on markets.

How does an investor handle the potential volatility driven by these political issues? The best course of action is to be diversified beyond US stocks.  Having stock exposure outside of the US could help limit any administration related market shocks.  For the year to date, foreign stocks have outpaced those in the US, but foreign stocks remain much less expensive with a price to earnings ratio that is 20% lower than their US counterparts.  In addition, maintaining a diversified high quality fixed income exposure provides a likely hedge to any drops in equity.  In times of severe market stress it’s been shown time and again that high quality fixed income, like US Treasuries, holds up very well.  In 2008, when the US stock market was collapsing, US treasuries rose over 11% for the year.  If there are any significant down swings in US stocks we do not recommend moving out of the asset class.  Instead we recommend waiting until your US stock allocation hits its predetermined minimum threshold and buying in to bring it back to its target allocation.  Other areas of the portfolio, like fixed income and potentially foreign stocks, could be up.  Thus investments that are up can be sold and reinvested in what is down.

By remaining disciplined to your target asset allocation, maintaining a very high-quality fixed-income allocation, and by diversifying broadly you can reduce the potential negative impact of any political drags on the market and remain focused on achieving your long term investment goals.

 

Index Performance      May YTDTrl 1 Yr
US Stock (Russell 3000)1.02%7.96%17.69%
Foreign Stock (FTSE AW ex US)3.26%13.89%18.80%
Total US Bond Mkt. (BarCap Aggregate)0.77%2.38%1.58%
Short US Gov. Bonds (BarCap Gov 1-5 Yr)0.23%0.95%0.58%
Municipal Bonds (BarCap 1-10yr Muni)1.09%3.32%1.50%
Cash (ML 3Month T-Bill) 0.05%0.22%0.44%

 

About

Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at www.raffawealth.com

 

There is no guarantee that any investment strategy, including those described here, will be successful. Any investment or investment strategy can lose money. Past performance does not guarantee or predict future results.  You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC.  This information was gathered from reliable sources but we cannot guarantee accuracy.  Indexes do not reflect the fees associated with actual investments and such fees would reduce the performance illustrated.

Without a Fully Diversified Portfolio you are Starting behind the Eight Ball

This month we have a guest blog post from Bloomberg, “The Math Behind Futility.”  The article examines research that looks at the question of why active managers underperform the benchmark so frequently.

If the fund you hold does not capture the entire asset class being targeted, missing just a few of that asset classes’ biggest winners may result in returns below the benchmark index.  This is why we recommend diversifying broadly across an asset class.  It eliminates the risk of missing the top performers.  Active stock funds have fewer holdings and as a result they are more likely to miss the biggest winners.

 

Index Performance    AprilYTDTrl 1 Yr
US Stock (Russell 3000)1.06%6.86%18.58%
Foreign Stock (FTSE AW ex US)2.20%10.30%13.31%
Total US Bond Mkt. (BarCap Aggregate)0.77%1.59%0.83%
Short US Gov. Bonds (BarCap Gov 1-5 Yr)0.32%0.72%0.20%
Municipal Bonds (BarCap 1-10yr Muni)0.64%2.21%0.34%
Cash (ML 3Month T-Bill) 0.07%0.17%0.40%

 

About

Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at www.raffawealth.com

 

There is no guarantee that any investment strategy, including those described here, will be successful. Any investment or investment strategy can lose money. Past performance does not guarantee or predict future results.  You should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management, LLC.  This information was gathered from reliable sources but we cannot guarantee accuracy.  Indexes do not reflect the fees associated with actual investments and such fees would reduce the performance illustrated.