Inside The Gearbox.
A current score direction review reveals that Non-US assets make up most of the improvers among the asset classes as we have entered into the seasonally weak market cycle. At #1 and #2 in score direction on the system are India and then Europe. The European group's rRisk is much lower than India's, therefore the concept of risk adjustment and consistency could come into play to say the European is the best idea among these improvers.
This inflection of Non-US improvement is indeed showing up in your inventory one way or another. If you are modeling or using models then you can see the infusion of Non-US exposure climbing in these mechanisms. As a segway towards examining this would be to look at the example of the flagship American Funds Top 5 MMPR50 model. This model recently updated and added the Small Cap World Fund SMCWX to the lineup. As you know, the model updates on seasonal quarters and the fund line-up does change on an active basis. While that sounds simple enough, the internal breakdowns of the asset allocation really reveal sophisticated asset shifting. As a case in point let’s dive into particulars about this latest allocation.
The weighting scheme of the model equal weights across 5 options, so each fund holds 20% of your money. Glancing at the current fund scores we can see that each of them are scoring better than 4. None of these score above 5 at this time as American Funds does not have a fund scoring 5 or better. The net weighted portfolio fund score is at a 4.49, well above the group score net average of 3.75. Each fund within the line-up is well above the average score of the groups in which they compete. The Morningstar rating nets out to a 3.60 as 2 of these funds are rated below a 4 on that system. The high score belongs to New Economy, which is among the lowest rated Morningstar fund in this field. Fund score is sensitive to the question of what should we invest in NOW, not focusing on the way things used to be.
From a portfolio incremental breakdown we can see a net equity weighting of 90%, which the highest equity weighting I have seen in quite a while. But what is interesting here is that the Non-US weighting has risen to 23% as of this update. Non-Stock and Cash are at 10% so what you have here is a 90-10 model footprint. This 90-10 is more of the highest aggressive weighting scheme we often see from this model. As it typically hovers around 70-30, possibly much lower at specific times. The high US stock weighing goes to Washington Mutual and the high Non-US goes to Small World. The high Bond position goes to Amcap with 2% and it also holds the high on Cash positions at 9%.
Concerning relative Risk, the higher rRisk values go to New Economy and Small World with a 1.13 respectively. The low rRisk goes to Washington Mutual with a .96. What is interesting here is that the Net weighted portfolio rRisk lands at a 1.05, well below the reading of the Average Group rRisk which would land at a 1.18. This set up gets you well above averaging on relative strength compared to the average strength of the asset classes, but gets you in that strength at a lower volatility than the average risk of those asset classes. This relationship is indeed a selling point to talk over with your clients and prospects.
The sector breakdowns can be seen here through Morningstar mechanics. You got it all here with the higher sector weighting going to Technology and the next spot going to Consumer Cyclicals. What you don’t have here is Real Estate and Utilities and Energy has a relatively low weighting. If you are in agreement with that, then this is a great allocation scheme for you. Real Estate has a current score of 2.81 and if you need that you could but another fund if you wish. The Non-US country high weighing goes to Asia Emerging markets and European Developed Markets. The top stocks held here are Microsoft and Amazon and Home Depot in the US with Avago Tech from China to get you started.
The result of a dynamic Top 5 Model can tell a wide story that many of your clients would want to hear about. Included in that story is the weighting scheme, the sector stratification, the country exposure and the top stocks that are in play. Though FSM is a simple strategy for you to deploy, it produces a vibrant picture for you to talk about. Summing up, a descent of appropriate benchmark for the model could indeed be the 70/30 split benchmark. Over time the model inflects exposure above that line and then also well below that line, not to mention that the whole model can go to 100% cash. From a Wealth Building point of view, the American Funds model defeats the benchmark long term. Along the way, the win ratio of single years is running at 80%. Put FSM to work for your clients.
*Images from Morningstar, courtesy of Morningstar.
