ETFs for ‘Lazy’ Fixed Allocation Portfolio

Copyright 2008 TheStreet.com, Inc.All Rights Reserved
TheStreet.com

November 18, 2008 Tuesday 09:19 AM EST

SECTION: NEWS & ANALYSIS; Investing

LENGTH: 705 words

HEADLINE: ETFs for 'Lazy' Fixed Allocation Portfolio

BYLINE: Roger Nusbaum, TheStreet.com Contributor.

At the time of publication, TIP, PLMIX and NARFX were client holdings, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

I wrote about new "ETFs of ETFs" from iShares last week. As I mentioned, people may have less interest in the market these days, but they still need to save, and grow, money for long-term financial success.

As a follow-up, here's how to use the iShares fixed allocation funds in a lazy portfolio of sorts.

The iShares S&P Aggressive Allocation Fund(AOA:NYSE) targets 91% equities and 9% fixed income. The proportion is fixed, as opposed to a target date fund that will move more and more to fixed income over time. AOA targets the S&P 500 at 32.9%, S&P Mid Cap 400 at 22%, S&P Small Cap 600 at 8%, MSCI EAFE at 20%, MSCI Emerging Markets at 8.1%, Lehman Aggregate Bond at 5% and Lehman TIPS Bond at 4%.

That mix makes AOA a decent proxy for equities, but AOA is not sufficient as a portfolio solution by itself. People need to determine their own suitable asset mix, but an investor with 15 or more years until retirement could start out with the following:* iShares S&P Aggressive Allocation Fund(AOA:NYSE): 65%* ELEMENTS Rogers International Commodity Index Total Return(RJI:NYSE): 5%* Nakoma Absolute Return Fund(NARFX:NYSE): 10%* iShares Lehman TIPS Bond Fund(TIP:NYSE): 15%* PIMCO Developing Local Markets(PLMIX:NYSE): 5%

The five products above are simply an effort to capture a diversified portfolio by including asset classes that, one way or another, are missing from the iShares fixed allocation funds.

RJI provides broad commodity exposure. I prefer it to similar funds for its breadth of commodities. RJI is down 35% year to date and 50% from its peak. This year has been rough on commodities, and RJI can't escape that. When commodities turn up, RJI will as well.

I've written about NARFX, an absolute return product, a couple times before. Year to date, NARFX is down 2.8%, which is pretty good in a 40% down world. The fund attempts to offer consistent returns with low volatility by implementing a long-short strategy.

TIP has a small weight in AOA but not enough to create concern about duplication. Asset prices have been deflating for a while, and the risk of higher inflation than we are used to becomes a big issue in the next few years as the Fed prints money to inflate out of the financial crisis. If that makes sense to you, a TIPS fund makes sense. If not, there are plenty of plain vanilla bonds funds that do not provide inflation protection.

PLMIX also benefits from inflation in the U.S. assuming that higher inflation is dollar negative. However, the fund has proven susceptible to a strong dollar. The fund is down 23% since early August (not including dividends). The dollar has panicked higher as the markets have melted down. At some point, that will end and the fundamentals should become more important. If so, PLMIX will prove to be a good hold.

The mix above covers a lot of ground for people who want to take a lazy approach, though it would have been crushed in this bear market, down 31% for the year compared to a 40% decline for the S&P 500.

My take from the above result is that you cannot set it and forget it. One very simple idea is to sell AOA (but keep the other funds) when the S&P 500 goes below its 200-day moving average (DMA) and buy back in when it goes above the 200 DMA. This strategy would have had the portfolio out of AOA the entire year (had the fund existed that long), and so the portfolio would be down 4.1% year to date and currently have a very large weighting to cash.

While that would be a great result, there are drawbacks, too. Occasionally, the market dances around its 200 DMA, so there would be some extra trading and commission dollars spent, but it would only be one fund being traded. Another problem is that the S&P 500 is now 30% below its 200 DMA. While it is likely the 200 DMA will keep heading lower and it is a good bet that when the S&P 500 crosses back over, it will be at a lower number than it was when it went below, which was around 1480. This means the market might go up a lot before the strategy lets you back in.

No portfolio or strategy can be perfect. The concept laid out here allows for capturing the general effect of the market without riding it all the way down and without spending hours working on something you've come to no longer enjoy.

LOAD-DATE: November 19, 2008