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That's Investing. Riding High in 2015, Shot Down in 20xx?

Summary: In this article, I delve a little deeper into my recommended Model Stock Portfolio funds to try to get a fresh perspective that cannot be found elsewhere. The snapshot that emerges, while hardly a guarantee of future success when investing in my many previously successful fund selections, is intended to further help result-seeking investors (not to mention myself) judge what might be the best choices going forward within a group of already highly recommended funds. Data is presented which also suggests that investors, not surprisingly but often to their eventual disappointment, tend to invest heavily in funds whose holdings are frequently tilted toward previously strongly performing but likely overvalued classes of stocks, rather than from those with a better chance of showing future strength.

It should go without saying that no one single or even multiple selection criteria hold the key to which funds you should hold on to and with what emphasis in your portfolio. However, in my Newsletters down through more than 15 years, I have tried to make the case that, while there are numerous good funds (or ETFs) to choose from, best long-term results are more likely when, even within a list of highly rated funds, one focuses on those composed of stocks that are relatively more undervalued vs. those made up of stocks which have already been "discovered," and therefore, likely have seen most of their potential run-up in prices already.

Expressed a little differently, some funds may have achieved their recent success by their emphasis on holding a preponderance of already recognized "winning" stocks and stock categories and continuing to ride those winners. A simple example is funds that hold a relatively large proportion of what has proven to be an amazing stock, Apple. The same may be said for funds that have a relatively high proportion of recently high performing technology stocks as a group.

Two such funds I have consistently recommended are the Vanguard Growth Index Fund (VIGRX) (or its equivalent ETF) and Fidelity Contra (FCNTX). The former currently holds 7.5% of the fund in Apple and 26% of the fund in Technology companies. The latter holds about 3.8% in Apple and 29% in technology stocks. Given the excellent performance over recent years of these fund components, the heavy weighting has given a boost to both these funds (and many other similarly categorized Large Growth funds), and been a contributing factor as to why these two funds have beaten the S&P 500 Index on average over many years.

But another even more striking example can be cited: funds investing heavily in Health Care, such as PRIMECAP Odyssey Growth (POGRX), Vanguard Health Care (VGHCX) or Vanguard Health Care ETF (VHT). Not surprisingly, the latter two highly narrow-focused funds have nearly all their investments in this one sector, a stock subclass that has on average returned over 20% annualized over the last five years. While, unfortunately, I have never included any of these funds in my Model Stock Portfolios, I have recommended at least one fund with a currently greater than a 20% weighting in Health Care, namely T. Rowe Price Value Fund (TRVLX), This fund's track record against its Large Cap Value category peers has been admirable over the last five years.

Beyond this, though, is where things get very murky. As an investor, do you want to stick with funds that invest heavily in stocks and categories that have shown a lot of past momentum in the hopes that this outstanding performance will continue? Or, do you want, perhaps, to trim down your holdings of such funds, and instead for at least the next few years, favor funds more heavily invested in stocks and categories that may show even greater potential for success, namely those choosing the majority of their investments in potentially less overvalued segments of the market?

Unfortunately, there is no clear cut answer to this dilemma. Therefore, it is probably wisest to own funds weighted in both, that is, funds that invest heavily in stocks with strong current momentum, and, those that can potentially become better choices when the former momentum-driven stocks start to lose altitude.

Unfortunately too, one of investors' biggest downfalls happen when the winds of change periodically cause a big shift in the performance of previously winning stocks, categories, and the funds investing heavily in them. While we haven't seen any such sort of massive shift going back perhaps to the 2007-2009 financial crisis, or even before, we know that many investors tend to suffer when outsized bets on previous winners turn into outsized losses.

While no one can say with any degree of certainty if and when the next reversal of fortune may befall the current crop of big winners in stocks, what follows is an analysis of which of my recently recommended funds are holding stocks perhaps overloaded with past winning, but now likely overvalued, categories of stocks. And, on the other side of the coin, can I identify which of my recommendations are more oriented toward current ownership in categories that seem to be less likely to underperform when the next big shift in stock market winners and losers takes hold and impacts fund results for possibly years into the future.

A Closer Look at My Model Stock Portfolio Funds

In the first list of funds below, I analyze broadly diversified domestic stock funds recommended (or recently so) in my Model Stock Portfolio to examine the above issue. I also include some additional funds that I hold in my own personal investment portfolio. Funds more broadly classified as international stock or narrow-focused sector funds, however, are not included.

For each listed fund, I have scored the fund on the extent to which it is currently (based on latest data available) invested in either what appear to be fairly-priced categories of stocks, or on the other hand, seemingly overvalued categories, based on my own proprietary research. See the note at the bottom of the list for the meaning of scores.

Each fund is listed in descending order of score, starting with those least likely to be overvalued. Those with greater potential for coming out on top over the next 3 to 5 years, assuming my scoring method proves valid, are listed closer to the top; those that may be strong winners recently, but having a greater potential for underperformance when their current chosen and often overvalued stock selections lose momentum, are found further down the list.

Note: If one compares the results shown in the list with the allocations shown in my Oct. '15 Model Stock Portfolio, the results may not completely agree with the recommendations there because the listing below is based on different data.

It should come as no surprise that all of the funds below, because they are diversified mixes of stocks, will have a moderate proportion of their investments in overpriced stock categories, given what we have previously labeled as an overall overvalued market. Therefore, inclusion in this list below in no way ensures that most or all of these funds will prove to be great investments over the next few years. But relatively speaking, we chose these funds, that is, those that are managed, aiming to beat market indices, or at least do well against their similarly classified peers. However, it is very possible, too, that perhaps some of the best investments for the next few years instead may turn out to be in funds that are invested internationally, as generally speaking, these fund categories seem to be relatively more undervalued than U.S. domestic funds are at the present time.

Best Model Stock Portfolio Choices (from most highly rated* to less highly rated)
Fund Name (Symbol) Score   3 Yr. Return
(thru 10-27)
1. T. Rowe Price Equity Income (PRFDX) 76% 10.6% Large Value
2. Vanguard US Value (VUVLX) 74% 16.5% Large Value
3. Fidelity Large Cap Stock (FLCSX) (tie) 70% 15.5% Large Blend
3. Vanguard Equity-Income (VEIPX) (tie) 70% 13.9% Large Value
3. Vanguard Small Cap Index (NAESX) (tie) 70% 14.7% Small Blend
6. Vanguard Extended Market Idx (VEXMX) 68% 15.0% Mid-Cap Blend
7. T. Rowe Price Value (TRVLX) (tie) 65% 16.4% Large Value
7. Vanguard Mid Cap Index Adm (VIMAX) (tie) 65% 17.1% Mid-Cap Blend
9. Vanguard Small Cap Growth Index (VISGX) 64% 13.6% Small Growth
10. Vanguard Windsor II (VWNFX) 63% 13.4% Large Value
11. Vanguard 500 Index (VFINX) 62% 15.8% Large Blend
12. Fidelity Contrafund (FCNTX) (tie) 58% 17.1% Large Growth
12. Vanguard Growth Index (VIGRX) (tie) 58% 16.9% Large Growth
14. Fidelity Low-Priced Stock (FLPSX) 55% 15.2% Mid-Cap Value
15. AMG Yacktman Service (YACKX) 39% 11.7% Large Blend
*Note: Top rating possible is 100%; lowest possible rating is 0%. A score of 70%, for example, means that 70% of the stocks in the fund are judged to be within a class of stocks that is fairly valued while 30% are within a category that my research indicates is overvalued.

Of course, funds in the above list that are managed (that is, not index funds) will have the option of switching out of overvalued categories if it is decided to make such a switch. Index funds must stick to their mandated benchmark and typically will not change their composition unless the underlying index changes.

Funds with the Most Investor Assets

As a basis of comparison with the above funds and to see alternative funds chosen by investors that have currently attracted the most investor assets, it is also informative to look at similarly derived scores of the most popular funds using the same criteria to rate each in terms of my measure of fair vs. overvalued stock portfolio composition. (The first list also includes some of the biggest funds; it also includes a few that mirror some of the most important indices such as the S&P 500 so we won't show funds that are identical or nearly so to those there. And, I again exclude international and sector funds.)

Biggest Funds by Assets (from most highly rated* to less highly rated)
Fund Name (Symbol) Score   3 Yr. Return
(thru 10-27)
1. Dodge & Cox Stock (DODGX) 71% 16.1% Large Value
2. Vanguard Value ETF (VTV) 69% 15.0% Large Value
3. American Funds Washington Mutual A (AWSHX) 67% 14.4% Large Value
4. American Funds Invmt Co of Amer A (AIVSX) (tie) 64% 15.0% Large Blend
4. Vanguard Total Stock Mkt Idx Adm (VTSAX) (tie) 64% 15.8% Large Blend
6. American Funds Fundamental Inv A (ANCFX) (tie) 61% 15.3% Large Blend
6. American Funds AMCAP A (AMCPX) (tie) 61% 17.0% Large Growth
8. American Funds Growth Fund of Amer A (AGTHX) 54% 16.8% Large Growth
9. Fidelity Growth Company (FDGRX) 50% 19.6% Large Growth
10. T. Rowe Price Growth Stock (PRGFX) 48% 19.9% Large Growth
*Note: See the Note under the first table.

If you look carefully over these two lists, you will notice that the majority of funds with the highest, that is, best forward-looking scores, are categorized as Large Value funds. And, almost equally noticeable, most of the funds with a large percentage of already "discovered" stock categories, especially in the second list, are Large Growth funds.

What this suggests is that the best opportunities for investors for the next several years would appear to lie in US stock funds that are classified as Large Value. Many Large Growth funds, if this analysis is valid, are likely to perform less strongly than Large Value funds because investors may have already realized most of the performance benefits of this category and are more likely to find both a greater degree of safety in Large Value funds when market conditions are no longer as bright, and a greater degree of return potential due to their less overvalued composition.

While there is no way to know for sure how long the current "momentum bias" will continue, as it very well may, investors might always want to keep in mind that over long periods of time, the best way to make money in stocks is to establish and maintain your positions when prices are relatively low. It seems apparent, however, that looking at the second list featuring those funds investors have the most money invested in, they seem to be opting for many funds, including unmanaged index funds, with a relatively greater degree of already "stretched" types of stocks.


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