In late April, I launched my 3rd model portfolio at Invest By Model. What horrible timing! It has worked out well, though. A little background, first.
Invest By Model began at an even worse time than the launch of my most recent model - in the middle of 2008! We launched the Top 20 Model Portfolio in late May. It's always fully invested, so of course it was hammered, but we ended the rest of that year beating the market pretty soundly. It was in 2009 and 2010 that the performance really took off, with returns much greater than the market or that I would have ever expected in a single year. This was done with a lot of trading, but the primary driver was just finding cheap stocks. There had been so much dislocation that the task wasn't really that difficult.
We also launched the Conservative Growth/Balanced Model Portfolio in July, 2008, and it too held in relatively well in 2008 and performed quite strongly in 2009 and 2010, though not as turbo-charged as Top 20.
As 2011 began, I was very optimistic about the market, but I tried to dial down expectations of relative performance, as I doubted it would be three straight years of beating the market as handily as we had with Top 20 in 2009-2010. Quite simply, the environment had changed, with ideas more picked over and less "low hanging fruit".
In April, my market call was looking spot on - little did I know that the market would peak the day after we launched the new ETF model: Sector Selector ETF Model Portfolio. As I indicated at the launch, I didn't expect that the model would add as much relative performance over the long-term as my stock-picking models, but the goal was to take advantage of opportunities between various parts of the market using low-cost ETFs and eliminating individual security risk. There are some other advantages too, especially for larger portfolios as I describe down below. Here is the way I describe the strategy (on the website):
The goal of Sector Selector is to beat the S&P 500 using solely ETFs, primarily those representing various sectors of the market. The model may hold up to 25% in cash and must hold a minimum of 50% US equities. A maximum of 10% may be invested in each of the following: Commodity, High-Yield or Bond ETFs. A maximum of 20% may be invested in dollar-denominated Foreign Equity ETFs.
So, unlike my Top 20 Model Portfolio, I have the ability to reduce market exposure. The basic strategies I can pursue include rotating between the ten economic sectors, biasing towards smaller stocks or branching out into international markets. I can also pursue commodities and fixed-income.
As I said earlier, I don't think I could have picked a worse day to launch, especially considering that I was bullish at the time (though I shared commentary with subscribers on the blog that accompanies Invest By Model that I felt as though the market was due for a consolidation, which looked to be playing out as I expected until late July). The initial portfolio had very little Small-Cap and had big exposure to Financials, Emerging Markets, Mega-Caps (totally gone now) and Technology. Ouch! While the whole market was obviously pounded over the next five months, Financials and EM were particularly disastrous. At the very worst point in early October,
When life gives you lemons, you make lemonade! I am proud lucky to say that though the market has yet to reattain the highs from late April, the SSETF posted a closing high-water mark and is now positive since inception. I say this not to boast, but rather to illustrate how patience and hard work can pay off for investors. As the volatility cranked up in the summer, we patiently adjusted the portfolios. The end result, which included several profitable trades along the way, was to boost the Small-Cap exposure as well as to recommit to preserving large exposures to Emerging Markets and Financials, which are really kicking in, finally, as 2012 begins. The S&P 500 is up about 7%, while our ETF for Emerging Markets has increased almost 16%, a little ahead of the 13% gain for our Financials ETF.
You can take a peek for yourself, as we offer a free 30-day trial, but I feel that after a two-month pothole (August and September) that I didn't handle as well as I could have that we are on the right track with this portfolio. In Q4, it returned 12.04% compared to 11.82 for the S&P 500, and it is up 12.89% in 2012 compared to 7.11% for the S&P 500. I have recently taken a little relative risk off by paring Small-Caps a bit to move into a sector of the S&P 500 that has lagged.
For those interested in affordable professionally guided investments, the SSETF model portfolio is easy to follow. We send out trade alerts in advance of the market for you to execute at your online brokerage. Trading over the past nine months has averaged about six trades per months and just two days per month with trades (excluding the 8 buys when we launched in April) . Here are all the buys and sells (establishing new positions, closing positions and adds or decreases):
- April: 8 (these were the initial buys at the end of the month)
- May: 7 (one two days)
- June: 3 (one one day)
- July: 3 (on one day)
- August: 5 (on two separate days)
- September: 8 (on three separate days)
- October: 6 (on three separate days)
- November: 4 (all on one day)
- December: 5 (on two separate days)
- January: 3 (all on one day)
So, as you can see, the demand on your time isn't that great. Leave the worrying and decision-making to us! While it may not seem like a lot of activity, let me assure you that the overall portfolio has changed rather dramatically over the past nine months. We no longer have 4 of the 8 initial positions, and our largest initial holding when we launched is no longer even in the model. It doesn't take a lot of positions to achieve reasonable diversification. We currently hold 8 different ETFs, and I would expect the number to range from 5 to 10 over time.
What about the cost? Just $10 a month to subscribe. This makes the model accessible to those with as little as $50,000 to invest in my opinion. Let me explain the math. The annual fee of $120 works out to be just 0.6% of the overall investment, but there are transaction costs that subscribers must cover. While it's possible to find accounts that offer a large number of free trades initially, I will assume that the transaction cost is $8 per trade. I estimate that over the course of a year, the commissions will run at $640 (80 transactions, including the initial buys). This would lead to a total cost of $760, which represents less than 1.6% of the portfolio. For "active management", this is in the ballpark compared to the alternative of investing in mutual funds. Consider that mutual funds pay commissions too, a lot more than $8 per transaction! This slippage, along with other hidden costs, isn't included in the quoted fees you might see from mutual funds. Of course, you can always just invest in SPY or another ETF designed to replicate the market at a much lower cost (accepting market returns). Again, if you can cut your transaction costs, you can justify applying the model to smaller portfolio sizes.
I have shown how the model can be applied to smaller portfolios cost-effectively - it really kicks in for large amounts. Unlike my Top 20 Model Portfolio, where we invest at times in some pretty illiquid Small-Caps that can move up on our buys or down on our sells, SSETF can be applied to very large portfolios without impacting the market. The economics are tremendous here. Let's look at the numbers. On a $500K account, the subscriber pays me the same $120 per year and entails the same transaction costs as I described above. Dividing the all-in cost of $760 into the size of the portfolio shows that the annual full cost is just 0.15%, which is a cost that can't be matched by any other provider of mutual funds (or separately managed accounts).
So, hopefully this explains what we are doing with this model, which is part of a series of strategies designed to empower investors who want to manage their own investments but are looking for affordable buy high-quality investment advice. As I said before, we offer a free look at the models, so check it out! As always, feel free to contact us with any questions or suggestions.
