Each year, we look closely at trends and valuations to create themes which will be incorporated into our Investment Porfolios. In addition to the Defensive Managers Select portfolio which we highlighted last week, our Premiere Wealth Portfolios are tactical asset allocation models with 10-15 funds or ETFs, at five risk levels: Conservative, with a benchmark of 35% Stocks/65% Bonds, Balanced (50/50), Moderate (60/40), Growth (70/30), and Aggressive (85/15). We are also rolling out a new allocation, Ultra Equity, which will be 100/0.
We will always remain broadly diversified, invested both in Core Assets, which we believe should always be in a portfolio, and in Satellite Assets, which are typically in a more narrow category which we feel offers a benefit to the portfolio at the present time. The Satellite holdings may be changed from year to year, and while the Core funds are “permanent”, their size and weighting in the portfolio will change each year based on their relative valuations and attractiveness of other categories.
We always start with the overall asset allocation in our process, and then choose funds which we think will accurately represent each category. With our themes each year, I think you will see that we are far from being entirely passive. Here are our big picture thoughts for 2018.
1) Foreign over Domestic Stocks. US Equities are quite expensive relative to the rest of the world. The strong performance in 2017 has stretched those valuations even further. We are presently overweight US stocks relative to our benchmark (the MSCI All-Country World Index), but will reduce our weighting to US stocks to an underweight.
2) Overweight Emerging Markets. For 2017, we increased our allocation to Emerging Markets Equities to two-times the level of the index, approximately 17% compared to 8.5%. EM had a phenomenal year in 2017, currently up nearly 30%. When we rebalance, these positions may be trimmed, but please note that we are not reducing our target allocation!
3) Reduce Risk in Fixed Income. While short-term rates rose nicely in 2017, long-term interest rates did not. This was our “low for longer” theme from last year. We sold our high-yield bond ETF over the summer, but will continue to look to reduce the duration of our bond holdings and increase the credit quality. When we do eventually get a correction in the stock portfolio, we want to have high quality bonds to provide support to the portfolio.
4) Increased Volatility. We don’t have a crystal ball and believe that trying to make predictions is not only futile but damaging to your returns. However, we have gone an exceptionally long time without any sort of correction. I don’t know when it will occur, but just as autumn turns to winter, I think investors must not forget that there will be down periods, and be prepared to weather potential storms in 2018 and beyond.
We published Four Investment Themes for 2017 in November of 2016. Click the link if you’d like to see how we did. I think we were generally successful in identifying themes for this year, except that I was expecting Value stocks to take the lead from Growth stocks, which did not occur. However, we saw the gap in valuation between Value and Growth widen in 2017, so I believe that Value offers less risk and potentially a higher long-term return than Growth.
2017 was the first full year to include a 10% allocation to Alternatives within each portfolio. With the stock market producing double digit returns in many categories, our investment in Alternatives was a drag on performance. Still, I think many investors will appreciate that we are looking for more stable sources of returns than just being in stocks and bonds. With high valuations in domestic stocks, and low bonds yields globally, risks remain elevated.
Overall, we will be making only small adjustments to our portfolios for 2018. But compared to two or three years ago, we have already made significant changes to reduce risk and further diversify our portfolios. As always, I am happy to discuss our investing approach in greater detail with anyone who is interested.