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5 funds to fill the gaps in your portfolio
Many investors ignore key market sectors and miss out on too much in returns. These funds provide the building blocks for a complete portfolio.
By Timothy Middleton
The hole makes the bagel -- otherwise it's a bialy -- but a hole in your portfolio can unmake your financial future.
This year, for example, if you're stuck with high-quality domestic stocks and bonds, such as the holdings of Vanguard Balanced Index Fund (VBINX), you're ahead a scanty 3.4%. My more-diversified model portfolio of exchange-traded funds, by contrast, is up 5.9%, aided by such asset classes as foreign stocks.
But many individual investors persist in limiting themselves to the options their parents had. For some investors, that means ignoring foreign markets. Many others own only what's popular at the moment, as was true with S&P 500 ($INX) index funds in the late 1990s.
That's a mistake. "Investment markets are highly cyclical, and the dogs of today are often the darlings of tomorrow," notes Pam Poldiak of Fee-Only Financial Planning in Roanoke, Va.
From the e-mails I get from readers and the comments of members of our Start Investing community, I know that many investors lack at least one of the basic building blocks of a diversified portfolio.
Growth, for example, has been all but forgotten in recent years as value funds have surged to the top of the performance ladder. Foreign stocks and bonds did poorly in the 1990s but have since demonstrated their worth. And almost nobody but professional portfolio managers uses funds that exploit such investment niches as commodities and convertible bonds.
So here are five pegs specifically designed to fill the most common holes in individual investors' portfolios. If your portfolio is lacking in any of these categories, one of the funds below could be just the one you need.
Related news and commentary on MSN Money
Growth stocks
Rainier Small/Mid Cap Equity (RIMSX) is a growth-at-a-reasonable-price fund, with the emphasis on growth. Even though that style of investing is out of favor, the fund is up 13.5% this year (through Friday), beating the market by nearly 10 percentage points.
"Rainier's growth funds typically participate nicely when the market is in an up phase and do an excellent job of minimizing losses when the market is in a downward cycle," says Roger Wohlner, a financial adviser with Asset Strategy Consultants of Arlington Heights, Ill.
The fund stumbled early this year because of an overemphasis on technology stocks, but that bet has subsequently paid off. The fund is also overweight business services, industrial materials and energy. The fund's expense ratio of 1.25% is below average for a small-cap fund.
Rainier has outperformed its benchmark, the Russell Mid-cap Growth Index ($RDG.X), in eight of the last 10 years; it missed in 1998 and 1999, when it refused to pay up for Internet stocks. Shareholders were rewarded in the bear market when the fund declined much less than its average peer.
Foreign stocks
Dodge & Cox International Stock (DODFX) features every attribute I prize: top performance, low expenses, negligible turnover and ethical management. The fund has returned an average of 25% in each of the last three years, better than 97% of its rivals, and has a low expense ratio of 0.77%.
The company only runs four funds, and two of them are closed to new investors, a sign that managers are more concerned about protecting existing shareholders than finding new ones.
Dodge & Cox is a value-oriented firm with an unusual strategy: All of its research analysts focus on bonds as well as stocks, and foreign securities as well as domestic ones. So they are unusually attuned to where the greatest values can be found.
Stock picking is so good that turnover of the international fund is 6%, implying an average holding period of more than 16 years. It seems self evident, but many investors don't appreciate the importance of low turnover. Assuming good performance, it means managers are almost never wrong.
Foreign bonds
Loomis Sayles Global Bond (LSGLX) is a darling of financial advisers. They like its broad exposure to the debt of developed and developing markets, as well as the depth of Loomis Sayles' outstanding bond-research department.
"At any point in time, there are (other) countries with higher yields than U.S. bonds, so it doesn't make sense to ignore a huge segment of the global market," says Warren F. McIntyre, principal of VisionQuest Financial Planning in Troy, Mich.
Although the fund also invests in high-quality domestic debt, more than half the portfolio's assets are tied to other currencies, which are not hedged against the dollar. That can hurt when the dollar is strong, as it has been recently, but a plus when it's weak, which it has been for most of the last several years.
Finally, a good international bond fund is almost impossible to find, as I reported when I last discussed the Loomis Sayles fund nearly two years ago. This one is a treasure.
Stocks and bonds that Wall Street ignores
Greenspring Fund (GRSPX) is an outstanding counterweight to a portfolio otherwise invested mainly in blue-chip stocks and gilt-edged bonds. Greenspring owns the exact opposite: small-cap stocks and busted convertible bonds.
Manager Charles "Chip" Carlson goes after what he calls inefficient markets, and small caps and busted converts are archetypes. Small companies don't sell enough stock to make it worthwhile for major Wall Street firms to assign analyst coverage. Convertible bonds whose convertibility option is worthless -- hence, busted -- are even less remunerative to investment banks.
The blend is half as volatile as the stock market, but over the last 10 years has delivered annualized returns of 9.6%, only about half a point less than the market.
"Our goal is to achieve steady consistent performance regardless of what the overall stock and bond markets are doing," says Carlson. "We want people to sleep well at night."
In 2002, when the S&P 500 crashed more than 23%, Greenspring went down only 6%. The following year, when the market rallied strongly, the fund did even better, delivering a return of 31.3%, 2.67 percentage points more than the S&P 500.
Commodities
Pimco Commodity Real Return Strategy D (PCRDX) has absolutely no correlation to stock returns, making it an excellent diversification tool for any portfolio. The fund is also attractive, says David J. Fernandez, president of Wealth Engineering in Scottsdale, Ariz., as both a hedge against inflation and as a play on worldwide wealth creation.
"Global growth is further increasing the demand for oil, energy and commodities," Fernandez says, pointing in particular to China, Japan and India.
The Pimco fund gets total exposure to the Dow Jones AIG Commodity Index ($DJAIG) by using financial derivatives, which cost only a fraction of the fund's assets. The balance, more than 80% of assets, are invested in Treasury Inflation Protected Securities. Thus the fund hedges against inflation two ways. It also provides a fat yield, which currently is more than 5%.
Virtually every portfolio needs funds like these to round out core holdings of big-company domestic stocks and bonds. They help reduce volatility, which alone cuts the odds of big losses in downturns. But they also contribute sometimes-outstanding returns of their own. The net effect is an investor's dream -- higher returns with less risk.
At the time of publication, Timothy Middleton owned the following securities mentioned in this article: Vanguard Balanced Index Fund.
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