Portfolio Newsletter 1Q 2015

It is with great pleasure I begin this newsletter by saying – every portfolio outperformed the market in the first quarter of this year!

The two higher risk portfolios outperformed the S&P 500 (net of fees) by a wide margin. The moderate portfolio not only beat the S&P 500 (net of fees), but outperformed similar retail moderate risk portfolios (the pre-packaged types people can buy on their own), also net of fees, by a sizeable margin. Even the two lower risk portfolios beat the S&P 500 (net of fees).

This strong performance can be attributed to diversification and sector selection in the equity portion of the portfolios. As you know, diversification helps smooth out the fluctuations during such a volatile market.

The bond market was not a smooth ride either. Interest rates fluctuated any time a member of the Federal Reserve uttered a word. Fortunately, those fluctuations were minimized due to the low duration focus in bond allocation.

You may recall a few changes were made to management of the portfolios this year. Among them:

  • Two portfolios for each risk class were merged to create more time to research funds.
  • Sector weighting the funds to focus on the top six sectors by expected performance.

As evidenced by the returns, these changes worked well. The portfolios were invested in the top five performing sectors, excluding real estate. More importantly, they avoided the three worst performing sectors.

Sector Update

Here is a brief synopsis of each sector in which the portfolios are invested:

Biotechnology – This is the number one performing sector. It continues to generate high returns aided by the rising dollar.

Healthcare – This number two performing sector also performs strongly as the value of the dollar rises. While this sector generally does poorly during the initial phases of a rising interest rate market, it may continue to perform well as long as the dollar continues to appreciate in value.

Consumer Discretionary & Technology – These sectors perform well during both a rising dollar and the initial phases of a rising interest rate cycle.

Financials – While this sector should perform well during both a rising dollar and the initial phases of a rising interest rate cycle, it has slightly underperformed the market this year.

Industrials – This sector should benefit from a rising interest rate market, but since interest rates have yet to rise it is underperforming.

Consumer Staples – While this is a defensive sector that should not be used during a rising dollar and rising interest rate cycles, it has outperformed due to the continuous volatility of the market. It offers the potential for above average returns due to low input (energy) prices and has delivered. This sector will likely be dropped at the next rebalance.

Portfolio Management Update

During the last rebalance I stumbled upon a subset of mutual funds that have no holding period. This means they can be bought or sold daily without a transaction fee or early redemption charge. The subset is comprised of a couple hundred funds that mostly look like index funds, which include sector focused funds presently in the portfolios.

There is risk in using sector funds. Hot sectors can go cold as cycles of the economy shift. If there is a holding period on the funds, the selling of a poorly performing sector will trigger a transaction fee or redemption charge that can lead to losses.

Using this subset of funds with no holding period will allow dynamic changes to the portfolio as the economic cycles change. Underperforming sector funds can be quickly removed without incurring fees or charges. They can then be replaced with funds in sectors that are performing well.

Schwab Institutional Intelligent Portfolios™ Update

At the end of last year I mentioned Schwab was planning to roll out a newly automated portfolio management system first to the general public, and then to institutional advisors. As expected, the retail version is very limited and specifically designed for younger investors who want an automated investing program.

I was hopeful the institutional version would be robust enough to simplify management of the portfolios for advisors. I was wrong.

Schwab said the new system was not designed or intended to replace an advisor’s current management, which was evident by the limitations placed on these types of accounts. There are investment minimums and additional fees, plus Schwab has limited investment options to a small number of Exchange Traded Funds.

Perhaps in the future Schwab will expand the technology for their institutional advisors to use with their current portfolios. Meanwhile, nothing will change in how your money is managed.