Portfolio 2 Updated April 2017

Portfolio Two is 12 1/2 years old.  The beneficiary contributed $6500 and the trustee $13,000 for a total of $19,500.  The current value is $33,334 for a gain of $13,834 which is 71% or 7.4% / year when adjusted for the timing of cash flows.  You can see the portfolio detail here or go to the links on the right.

This portfolio is different than the other portfolios because it has shifted to ETF’s and CD’s.  The ETF’s are broadly tied to the US and non-US stock indexes.  There is also a CD that returns 1.55% / year for $10,000 in the portfolio.

Since markets have gone up over the last year, this portfolio has done well (it tracks the market).  All of the ETF’s are near 100% of their 52 week high, which means that they are at or near their highs and the indexes have been rising continually over this time period.

Unlike the other portfolios, which are invested in individual stocks, these ETF’s do have annual expenses.  You can’t “see” the expenses because you receive the returns “net” of expenses, but this is disclosed.  Over the 1 1/2 years that we’ve had this portfolio the low cost ETF’s cost $86, which is very low for a portfolio of over $30k.  If you go back ten or fifteen years ago mutual funds would routinely cost 2% or more each year which would be $600 / year on a portfolio of this size.  It is a testament to the efficiency of ETF’s (which drove competition in the mutual fund markets, mutual fund expenses have been driven down proportionally, as well) that these sorts of rock bottom expenses are now commonplace if you know where to look.

In a technical note, the CD does fluctuate in value (a bit), but I record it at cost ($10,000) since we intend to hold it to maturity.  The cost fluctuations thus do not matter.

Finally, in another note, when I moved this portfolio over to Google Sheets, I noticed that I had been overstating the contributions in the “cash flows” calculation since 2012.  Thus the recorded return since inception now looks higher.  The value of the fund was always correct it was just the calculation of total gains to date that was incorrect.


How We’ve Fared in the Last Year

It is about time to pick stocks for 2014 (we time it to the “back to school” end of summer so that the beneficiaries get time to earn their $500 so that we can match them) and I spent a bit of time looking at performance for all the funds (as one consolidated entity) vs. the market.

The first item of note is that it has gotten exponentially easier to do any sort of analysis with all of the free tools available on the web and the graphing and analytical tools that you get from your brokerage account (they vary, but all are likely powerful).  What used to take hours can essentially be done in minutes.

In addition, the tools and analytics are smarter in that they (usually) attempt to take into account dividends and remove net investment from the equation (i.e. if you contribute “new money” this doesn’t show up as part of your return).  Not all the indexes take dividends into account, however, so you need to be careful. In this analysis SPY is the ETF for the S&P 500 which does include dividends.  The second ETF is for VXUS, the Vanguard ETF for non-US stocks.  Since we attempt to offer a mix of US and non-US stocks, the return “benchmark” in the simplest sense is about half way between SPY and VXUS.

S&P 500 and Vanguard Non-US Stock Performance for 2014 YTD

By this measure it would seem that our target benchmark performance for the year would be about 15%.

Screen Shot 2014-07-27 at 6.39.59 PMIn the last year our return has been 22.9% (the 12.9% is the 5 year return).  Thus we have done pretty well, in total across the six funds, for the last year.  Every fund, however, fares differently as a result of the stocks that they’ve selected over the years and what has been retained and what has been sold.


Actively Managed Mutual Funds

In the “efficient markets” hypothesis, all available information is factored into the stock price, making attempts to “beat the market” by selecting your own stocks a fool’s errand. Index funds, which were originally stock mutual funds, such as those at Vanguard, not only attempt to mimic rather than beat the index, they also sport much lower expenses. Thus even if the performance was the same for an index as a stock picker, the index would win with costs as low as 0.2% / year as opposed to 1% – 2% / year for managed funds. One advantage that remained of a stock selection methodology over mutual funds was related to taxes – individual stocks were definitely more tax efficient if handled correctly; now index ETF’s have erased that lead.

Of course, theories don’t always work in the real world, as the recent financial meltdown attests, when AAA rated financial instruments took significant losses. In a similar vein, those in favor of active stock selection could always point to a few candidates to make their cases. One candidate was Bill Miller, head of the Legg Mason Value Trust, who beat the S&P 500 for 15 consecutive years.


While Bill Miller may have been the “poster boy” for those that point to active stock pickers, he was a reticent candidate. He even said that a lot of his “streak” was due to timing on the calendar and didn’t strut around like a world-beater. Thus I didn’t take much pleasure in the this article…

Bill Miller, whose Legg Mason Value Trust achieved the unlikely feat of beating the S&P 500-stock index for 15 consecutive years, has become the fund world’s punching bag. So far this year, the fund is down a devastating 56 percent on account of bad bets on stocks including AIG, Washington Mutual, and Freddie Mac. This horrific year (combined with lackluster results in 2006 and 2007) has banished Legg Mason’s crown jewel to the ranks of the worst-performing mutual funds not only for the year, but for all standard periods of measurement.

Actively managed funds did terribly in the current stock market environment, and index funds also fared poorly. The delta between the two is the “negative alpha” of active management (sorry, not everyone will get that, but I find it a bit funny) as well as the increased expenses of the actively managed fund over the index (it may be up to 6x bigger, as they say in the Vanguard adds, but unfortunately that is only a small percentage of the overall loss).

Due to the way that ETF’s are structured, there are basically no “actively managed” ETF’s. And ETF’s are more tax efficient than mutual funds. Thus when you pick an “actively managed” mutual fund, you are losing three times:

1) you probably are going to come in worse than your index performance
2) you will almost certainly pay higher fees
3) by selecting a mutual fund over an ETF, you are sacrificing tax efficiency

Bill Miller is among the last of the “index beaters”. The marketing departments for actively managed mutual funds are going to have to think hard to make this one shine…

Cross posted at LITGM