One of the major learnings this past year has been all the "tricks of the trades" used by active mutual fund managers to beat their performance benchmarks (usually S&P 500 Index) -- smart stock picking, fundamental research, sector overweight, momentum chasing, etc, etc .... But, at the end of the day (or quarter or year), we all know (even the retail brokerages admit this), on average, the fund managers do not consistently beat the market averages.
Retail brokers tend to showcase their "star performers" in their marketing materials; typically, beating the index by 4% annualized return over a long period (5 to 10 years) is considered "top of the class." Very often, the retail investors get ""sucked in" to buy these funds after the out-performance period ... unfortunately, they only get to experience the "convergence back the mean." With the popularity of ETFs and the vast amount money being controlled by hedge funds, it's become harder and harder for the mutual fund managers to beat their performance benchmarks, yet these people get paid the most within their industry. Personally, I only own mutual funds where there is no other alternative for me (to play a particular sector / asset class in a liquid / diversified way).
What's absolutely fascinating to ponder is that those "front line" people (the "financial consultants" or "account representatives"), who probably get paid much less by the industry, actually drive much more of the total portfolio performance. They use primitive tools to first determine an investor's risk profile, lifestage, income expectations, and financial goals; then they run some simple models (using long-term average returns and basic "simulations" on maximum drawdowns) to magically come out with recommended allocations of 60%/40% or 80%/20%. Once you are labelled a "conservative" or "aggressive" investors, you are supposed to stick with the plan (regardless of the economic cycle or market conditions). It's amazing to me that this 1-hour process of coming up with recommended allocation of say 40% equities, 60% equities, or 80% equities has a much more dramatic impact on the portfolio returns. For example, 20% change in equity allocation in a market that moves +/- 20% each year produces (magically) the 4% annual return differential.
Personally, I rather spend all my time worrying about asset allocation and how to dynamically manage the portfolio through various macro-economic and market environments. Maximizing long-term performance is simply the sum of maximizing short-term performance ... this way, no excuses can be given after a bad quarter or year using phrases like "... in the long-term, it will all be fine ... trust me (again) ...."
All of the smart and highly paid people in the retail brokerage world are working to beat the S&P 500 index ... I'm not smart enought to do that, so I will settle for average (index) performance within an asset class. Instead, I'll choose what I consider to be an easier battle -- compete with the lower paid people who drive the asset allocation decisions using some investor risk questionaire!
Perhaps this is what the hedge fund guys already do -- but there is no simple and low-cost access to hedge funds by the "average retail investor." Maybe then my goal should be to replicate hedge fund strategies and peformance without paying the 2%/20% fees!
Just like the mutual fund managers use silly tricks to beat the S&P 500 Index, I'll start creating my own "silly tricks" to beat the standard textbook conservative allocation that I'm using to measure my portfolio performance.
Here is the current allocation of the 529 Index: 41% US Equities, 15% International Equities, 36% Fixed Income, and 8% Cash.
Range of Outcomes for Q2 2010
Best Case: US Equities SPY $125 (+7%); International Equities (+7%); Fixed Income (treasury yield flat or slightly down) (+2%) ... Total Portfolio (+4.6%).
Average Case: US Equities SPY $120 (+3%); International Equities (+3%); Fixed Income (treasury yield rise to offset interest payment) (+0%) ... Total Portfolio (+1.7%).
Worse Case: US Equities SPY $110 (-6%); International Equities (-6%); Fixed Income (treasury yield spike to 4.2%) (-5%) ... Total Portfolio (-5.2%).
Tricks to Beat the Benchmark in Q2
US Equity: Overweight few sectors (XLV, XLE); short overbought sector (XLY); harvest call premiums; add to covered call positions on 5-8% market corrections (possibly XLF, QQQQ covered calls).
International Equity: Avoid Europe or anything that could lose money in US$ terms; overweight few countries (FXI, EWT) and Asia Pacific Fund; harvest call premiums; short overbought currency (Yen).
Fixed Income: Overweight high yield, convertible, and real-return funds. Avoid US treasuries all together (would be great to short it, but TBT not working out). Hold some corporate and muni bonds going into Q2, buy more on any spike in "risk-free" interest rates.
Cash: Maintain much higher cash for liquidity and take advantage of market corrections. They (the benchmark) only have 8% money left to buy anything that becomes cheap, while I have 30-80% cash on the sidelines depending on the portfolio. Also, I can short anything that becomes too expensive ... depending on the market conditions, the short positions could actually contribute to the overall results in a more meaningful way.
ACTION: Stick to game plan to see what happens on June 30, 2010.