The Passive-Aggressive Investor For 1/20-1/24

This week, an article from Morningstar perfectly encapsulates the central thesis of this investment newsletter:

Around 40% of active funds generated higher net returns than their benchmark indexes in 2019, 53% before fees. This does represent an improvement from a dismal 2018 campaign when fewer than one third of active funds beat their bogies net of fees.

This isn’t that surprising. Last year was a great year for the market, creating a, “rising tides lift all boats” scenario. However, what about the possibility of repeating that performance (emphasis added)?

Finally, we took a closer look at active funds that had succeeded in a given calendar year to see how many of those funds were “repeat” (that is, two successful calendar years in a row) or “threepeat” (that is, three consecutive successful years) winners. What we found was that 12% of the 1,999 active funds that beat their benchmark in 2019 had achieved that same feat in 2018, and only 16% had pulled off a hat trick by topping their index in 2017 and 2018. In other words, around 11% of all active funds were repeat or threepeat winners in 2019.

The possibility of continually beating the averages is just slightly better than 1 in 10. And that’s in an environment when the market did extremely well. What about beating the markets in multiple years in difficult environments? I sincerely doubt the odds improve.

Today, instead of discussing specific dividend aristocrats, I’m going to add a few ETFs to the regular watchlist and also add two more model portfolios.

Remember that our goal is to buy the “haystack” and not the “needle.” With that in mind, let’s look at the final “core” portfolio of ETFs that we’re going to monitor:Let’s start with the bond components. There is actually a pretty good selection of bond ETFs now. There are targeted ETFs, mortgage-backed, floating-rate, sovereign bond markets, and more. However, this newsletter is as much about ease as it is about analysis. And for the average investor, a few ETFs are really all they need. So, I’ve got four ETFs:

  • BND, which covers an incredibly broad swath of the bond market: “This popular ETF offers exposure to entire investment grade bond market in a single ticker, with holdings in T-Bills, corporates, MBS, and agency bonds.” Expenses are low (.04%) while the current duration is tilted toward the short-end of the market.
  • BNDX: this is more or less the same thing as BND, but with an international bent (” Includes government, government agency, corporate, and securitized non-U.S.investment grade fixed-income investments all issued in currencies other than the U.S. dollar). Again, instead of targeting specific bond markets, we’re buying the whole kitten kaboodle.
  • TLT and IEF: these two ETFs give us exposure to key parts of the US treasury market. Why? The US treasury curve is the key interest curve for everybody else. Some investors will want exposure to these ETFs because they diversify a portfolio with lower-risk, interest-bearing securities.
  • PFF: This is a hold-over from my days as a broker. I used to work with a guy who opened a ton of accounts by pitching preferred shares. This section of the market gets precious little coverage even though these issues give us great yield in an equity instrument. I consider preferred shares more as bonds than stocks, which is why they’re on this list.

Next, let’s look at the equity indexes. Again – remember the audience and the overall goal: ease of tracking (meaning we don’t want a monster list) and breadth of coverage:

  • SPY, IJH, and IWM: these are ETFs that track large-caps, mid-caps, and small-caps, respectively. Ideally, investors with a longer time horizon or more risk tolerance would invest in the IWM; those in the middle-range would use the IJH, and those in the shorter-range, more conservative camp would use the SPY.
  • VEU: this is a broad global average of equity markets. There are a number of international options: country-specific ETFs, regions, and others. But following all those averages and data is very cumbersome; from an “ease of use” perspective, the simplest method is to use a broad average.
  • IDV and VYM: I love dividends: in my opinion, they’re management’s best way of rewarding shareholders. These two ETFs allow investors to participate in a large number of dividend-paying shares domestically and internationally.

So – how did I pick each of these ETFs? I looked for a combination of size, liquidity, and expenses. I’ll take a bit more liquidity and size over expenses. Bigger usually provides a bit more safety. Those are just the parameters I like; these are points on which reasonable minds differ.

Finally, let’s introduce two more “model” portfolios:Data from; author’s calculations. Green means in increase, while red means a decrease. The first number in the left column is the SPY or VEU percentage, while the second number is the TLT or BNDX percentage. If you’re more conservative, opt for the higher TLT or BNDX percentage portfolio. If you’re aggressive, reverse the process.

The top portfolio is the standard SPY/TLT model. The second portfolio is the same idea but with an international bent. The VEU is the global equity, non-US ETF while the BNDX is the global bond market. The third portfolio is what I call the “25×4” because it’s balanced 25% to the SPY, VEU, BND, and BNDX. The idea here is simple: an evenly-balanced portfolio between the US and international equities, and the US and international bond markets. The 25% per ETF is entirely about ease of allocation.

Notice that international equities and bonds have underperformed their US counterparts during the last year. This is due to the global trade slowdown which appears to be stabilizing at low levels. Should that be the case, international equities should start to perform better. However, global tensions are higher (Middle East, India, China), which supports a safety bid for US assets.

Next week, I’ll return to discussing top and bottom performing and yielding dividend aristocrats. Have a good week.

Disclosure: I am/we are long PFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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