October 2023 Recipe Investing - Commentary

Topics this month

• One country fund stands out above the rest
• The few positive portfolio recipes this month
• The Fidelity Puritan fund vs. 80% equity / 20% bonds
• A mutual fund with >10% annualized return over the past 15 years

Welcome to the October 2023 commentary from recipeinvesting.com. We track investable portfolio recipes that allow investors and advisors to build portfolios that minimize risk and maximize return. We reallocate and rebalance monthly, so we have plenty of new material to cover for our comparisons this month.

Let's look at some of the ingredients first. Our list of Portfolio Ingredients are exchange-traded funds that fall into three categories:

• Global Sectors
• Global Asset Classes
• Global Equities

One country fund that stands out above the rest

Some of these ingredients are utilized in our Portfolio Recipes, and by analyzing them, we can gain insights into the extent of our focus on particular countries or industries. When we sort the Portfolio Ingredients table by one-month returns, we can observe the perils of over-concentration. Specifically, we notice some country-specific ETFs that have struggled significantly in the past month. Take Argentina, for example; it has performed well with an 8.7% annualized return over the last 15 years, but this success is accompanied by substantial losses over the same period. It's a high-risk, high-reward fund. Assessing the balance between risk and return is a recurrent theme here at RecipeInvesting.com.

This month, we have a limited number of positive ingredients. If we refer back to the portfolio recipes summary, and when we sort the table by one month, it's apparent that there have been few positive returns in the past month leading up to September 2023. Interestingly, all of these are actively managed funds, including exchange-traded funds and mostly mutual funds. We have some market-neutral options such as the Vanguard Market Neutral (VMNFX) and benchmark-free choices, such as the GMO Benchm-Free (GBMFX) Fund. These types of funds have managed to generate a positive return in the last month, but not without some associated risk. In fact, in many cases, their performance has been rather lackluster over the past 15 years. While a few have achieved a 5% return during that period, others have implemented absolute strategies.

The Absolute Strategies I (ASFIX) return fund has experienced a 10.5% decline in the past year, and its annualized return over the last 15 years has dropped to just 0.9%, averaging this annually. It's clear that this fund's performance does not align with what I would want in my portfolio.

The Fidelity Puritan fund vs. 80% equity / 20% bonds

Continuing to analyze this list of portfolio recipes and making comparisons, one key aspect to consider in the risk-return trade-off is whether actively managed funds significantly differ from static or strategic strategies. Let's focus on the Fidelity Puritan (FPURX) fund as an example.

While it may have shown a slight decline this month, its performance over the last 15 years has been strong, with an annualized return of 8.8%. To delve deeper into this fund's characteristics, we can examine its risk-return scatterplots.

We have a chart using downside deviation on the x-axis and absolute return on the y-axis, providing a clear visual of risk versus return. What's intriguing is that the Fidelity Puritan fund, denoted by the orange dot on the chart, consistently falls right in between the aggregate bond fund or U.S. Bonds (BND), shown as the purple dot, and the all-equities S&P 500 (SPY) exchange-traded fund, represented by the blue dot. This positioning shows a balanced risk-return profile for the Fidelity Puritan fund. Drawing a line from the purple dot to the blue dot, we can observe that the Fidelity Puritan Fund (in orange dot) aligns closely with that line. This suggests that we could replicate the risk and return profile of this fund by blending a certain ratio of a broad-based equity fund with a broad-based bond fund.

This ratio would lean more towards equities than the Strategic 60-40 Portfolio (s.6040), considering that the teal dot represents the Balanced (60% Equity / 40% Bonds) fund. Perhaps the Strategic 70-30 Portfolio (s.7030) or Strategic 80-20 Portfolio (s.8020) would yield a performance similar to that of the Fidelity Puritan Fund, and this trend has remained consistent over the past 15 years.

Let's quickly examine the Strategic 80-20 Portfolio. It appears quite similar on the scatterplots to the Fidelity Puritan Fund and, in some instances, might even outperform it. With our 80/20 allocation between equities and bonds, it aligns neatly along the anticipated line.

This offers some valuable insights when the investor assesses an actively managed mutual fund, which, of course, comes with associated fees and expenses. There might be a way to mirror the risk-return profile through a combination of a low-cost equity fund, a cost-effective equity exchange-traded fund, and an economical aggregate bond fund. This allows the investor the flexibility to choose their position along the spectrum from the blue dot to the purple dot.

Before we conclude, there's one more aspect to consider. It's clear that this month has presented some challenges for our portfolio recipes. Now, let's turn our attention to the list. We've organized it in descending order based on one-month performance. However, let's take a moment to scroll through the 15-year return list and see if there are any funds that have demonstrated strong performance over the past 15 years while also achieving a positive or at least not significantly negative return in the last month.

Here, we have the Robeco Long/Short I (BPLSX) fund, showing an impressive 9.7% return with only a 1.1% downside in the past month. It's worth noting that this is an institutional fund, usually not accessible to retail investors. As we've discussed previously, this fund is making a strong case for its value by maintaining a solid 15-year return and mitigating some of the impact during recent periods of volatility.

A mutual fund with >10% annualized return over the past 15 years

Among the returns over 15 years, we can identify a few that have come close to reaching a 10% return. Notably, the first fund on this list with a return greater than 10% is the Columbia Dividend Income (LBSAX) fund. While it experienced a -3.5% return in the past month, it's worth noting that this is the first fund in the list to surpass the 10% mark. To gain a deeper understanding, let's take a closer look at the Columbia Dividend Income fund.

The Columbia Dividend Income fund presents a somewhat distinct profile. When we assess its maximum drawdown over these previous periods, it's positioned above and to the left of the Balanced (60% Equity / 40% Bonds) portfolio. This positioning indicates that it has achieved a higher return, represented on the vertical axis, with lower risk, as demonstrated on the horizontal axis. It's undeniable that over the 3-year period, the Columbia Dividend Fund, depicted by the orange dot, has outperformed what a balanced portfolio would have delivered.

When we examine downside deviation, it might not look as favorable, but it follows a similar pattern to that of the Fidelity Puritan fund. We can draw a line between the all-equity portfolio (S&P 500) and the all-bond portfolio (U.S. Bonds), and many of the promising portfolios seem to align along this line. The orange dot, representing the Columbia Dividend Fund, is somewhat closer to equities. This suggests it might approximate a 90/10 split between equities and bond funds if we were attempting to replicate the fund's performance using only two exchange-traded funds.

Indeed, one way to evaluate mutual funds, especially actively managed ones, is to assess whether they can outperform straightforward and cost-effective portfolios built with just a couple of ETFs. This can serve as a practical test to determine if they are justifying their fees by making numerous active trades, which may drive costs higher compared to indexed exchange-traded fund portfolios.