Client Letter: Portfolio Allocation Changes

Client Letter: Portfolio Allocation Changes
We completed our regular rebalancing process last week, and you may have noticed some activity in your accounts. In conjunction with this rebalancing, we also made a few changes to our investment policy allocations in light of future expected returns. These changes are done only when the change is expected to add sufficient value to the expected returns and risk management of the portfolios.
Costs are always considered when evaluating funds and making changes to portfolio allocations. In this regard, we are happy to announce that due to the growing level of assets under advisement we manage on behalf of our clients we have negotiated a reduction in the transaction charge paid on the institutional funds used within the portfolios. The cost has decreased from $25 to $20 per trade – a 20% decrease. As a reminder, the ‘institutional class funds’ are the lowest cost share class available and often carry minimum investments of $1M to $5M. Using these share classes results in lower total costs for you.
Given market conditions today, it is truly a difficult task to build an all-weather portfolio for the coming years. Generally speaking, both stocks and bond appear expensive. Owning these assets at a higher price today negatively impacts forward looking returns. Increased volatility and lower expected returns in the coming decade are warranted. (See Investment Returns: What Should We Expect Going Forward?) Just know that this scenario is planned for within your retirement and cash-flow plans.
Below is a brief summary of the allocation changes.
Fixed Income Category
Added PIMCO Income Fund Institutional (PIMIX). This fund has been part of the portfolio for years, as it has been owned through the PIMCO All Asset fund (see ‘Alternative’ section below). This fund is a more flexible, multi-sector fixed income fund than the other core fixed income funds in the portfolios and is global in nature. This fund currently has significant allocations to U.S. mortgage bonds – many adjustable rate — that should perform well in an improving U.S. economy and likely rising interest rate environment.
Alternative Category
The ‘Alternative’ asset class should be thought of as assets that are dissimilar to stocks and bonds with expected returns and risk level between the two asset classes. The dissimilarity adds a diversification benefit to the overall portfolio. While Dimensional Fund Advisors (DFA) mutual funds remain the core of our portfolios in both equity and fixed income asset classes, alternatives have become a larger portion of the portfolios over the last few years as expected returns for stocks and bonds have become less favorable.
We removed DFA Global Real Estate (DFGEX). DFGEX comprised a relatively small portion of 4-5% of client portfolios after being as high as 12% in 2009. Real estate is still owned marginally through equity funds and PAAIX and in effect, we are removing an overweight position. Higher valuations and increasing interest rates domestically make expected returns challenging over the coming years.
For most clients, we switched the AQR Managed Futures Fund Institutional (AQMIX) to the AQR Managed Futures High Volatility Institutional (QMHIX). QMHIX has a higher annualized volatility target 15% vs. 10%. The reason for the switch is that QMHIX allows a more efficient exposure to the asset class, based on cost per unit of risk. For example, a 7% allocation to AQMIX could be replaced by a 4.7% allocation to QMHIX.  The freed-up 2.3% could be reinvested into another fund and thereby increase the overall expected return of the portfolio. (Remember: this fund is designed to have a high volatility but volatility in itself does not matter. Rather, it is non-correlated to both stocks and bonds in the rest of the portfolio, and this non-correlation and higher volatility help increased expected risk-adjusted returns to the entire portfolio over time.)
We added Wells Fargo Absolute Return Institutional (WABIX) managed by GMO. GMO is an institutional money manager whose expected return forecasts are well known and followed throughout the investment management industry due to their history of accuracy. This fund is very flexible in nature and allows GMO to change the allocation within the fund to try to avoid overpriced assets and capitalize on those that are relatively underpriced. As of June 30, 2015, this fund had ~41% of assets in equities, which are down from ~60% equities a year ago.
We reduced PIMCO All Asset Institutional (PAAIX). The Wells Fargo/GMO fund WABIX and PAAIX have similar expected return forecasts for many asset classes but implement these forecasts within the fund differently. PAAIX per its prospectus mostly implements by using various types of bonds – inflation related, high yield, emerging market, etc. — whereas WABIX is unconstrained but historically tends to favor equities for implementation. Thus, the two funds combined do not dilute the tactical positioning of this portion of the portfolio but rather diversify the way the positioning is being implemented.
Equity Category
U.S. and international developed equity allocations stayed approximately the same with only a minor and general increase toward international developed equities. Emerging market equity allocations were increased by 1-4%, depending on the portfolio risk level.
For the TWD 10 aggressive portfolio, we also added increased value-tilts to both international developed (DISVX) and emerging market (DFEVX) equities.
This material is based on public information as of the specified date, and may be stale thereafter. True Wealth Design has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.