Insightful Investing

The rise of interest rates in the 4th Quarter has prompted a few changes to the Bond side of our portfolios. The most significant change to our Asset Allocation is the addition of a 4% allocation to Floating Rate Loans with a subsequent reduction by 2% each to Intermediate Bonds and Cash.

This resulted in the addition of several new funds to our list of Top No Load Mutual Funds during the quarter, including Fidelity Floating Rate High Income (FFRHX), RidgeWorth Floating Rate High Income (SAMBX). In addition we have also added Brown Capital Mid-Cap (BCMSX), Fidelity Dividend Growth (FDGFX), Oakmark International (OAKIX), Driehaus International Small Cap Growth (DRIOX), and Fidelity International Small Cap (FISMX).

We have no changes to Best ETFs List of Exchange Traded Funds for this quarter as we watch a few new entrants to the ETF marketplace. It is important to see if they build up enough volume to warrant further investigation for possible future inclusion in our list.

Asset Allocation January 2011

The fourth quarter was almost a carbon copy of the third quarter for Stock Mutual Funds. This turned out to be a good thing, as in both cases weakness in the ‘middle’ month was just a bump in the road to a quarter of strong performance, with strong yet volatile results. The big difference was the final quarter of 2010 was led by domestic Small Cap stock funds. On top of that list was Dreyfus Opportunistic Small Cap (DSCVX) which gained 21.3% for the quarter and 32.4% for the year. A couple of other strong performers were Fidelity Small Cap Discovery (FSCRX), which gained 17.3% for the quarter and 32.4% for the year, and Parnassus Small-Cap (PARSX), which picked up 17.1% for the quarter and 37.4% for the year. Our top Mid Cap fund was Westcore Select (WTSLX) which gained 17.3% this quarter and 24.4% this year, while our top Large Cap Fund was Wells Fargo Advantage Growth (SGROX) which earned 14.4% this quarter and 26.6% this year. Small Cap was a good them for International stocks too, as Harding Loevner International Small Company (HLMSX) gained 10.2% for the quarter and 23.5% for the year, while Wasatch Emerging Markets Small Cap (WAEMX) earned 8.5% this quarter and a list leading 41.2% in 2010.

All Bond Funds were negatively impacted by rising interest rates in the 4th quarter, but High Yield Bonds and our newly followed Floating Rate Loan Funds provided enough income to compensate some for the fall in debt security values. Fidelity High Income (SPHIX) earned 3.5% in the 4th quarter and 13.7% for 2010, Metropolitan West High Yield Bond (MWHYX) picked up 3.4% this quarter and 13.9% this year, while Fidelity Floating Rate High Income (FFRHX) returned 2.8% for the quarter and 7.8% for the year.

If you were willing to target specific sectors or countries, there were some even stronger performances by our ETFs. With all the talk about gold, you would have done considerably better had you invested in iShares Silver Trust (SLV) which gained a whopping 38.6% this quarter and a stellar 79.4% in 2010, or at least PowerShares DB Precious Metals (DBP) which is invested 20% in Silver and earned 14.70 in the 4th quarter and 37.7% for the year. A couple of other strong performers were SPDR S&P Retail (XRT) which added a surprising 37.1% in 2010, while Energy Select Sector SPDR (XLE) earned essentially all of its return for the year in the 4th quarter with a return of 22.1%.

Building on its early lead, the leading country ETF was iShares MSCI Chile Index (ECH) which picked up 45.8% in 2010, while iShares MSCI Mexico Index (EWW) picked up 17.1% in the 4th quarter to push its full year return to 27.5%. Domestically, iShares Russell Microcap Index (IWC) topped our ETF charts in the 4th quarter with a 19.3% return, while iShares S&P MidCap 400 Growth Index (IJK) earned 30.3% for the year, followed closely by iShares Russell 2000 Growth Index (IWO) which returned 29.1% for the year.

Our January 2011 Mutual Fund Portfolios, ETF Investment Portfolios, and Best Fidelity Funds have been updated through December 2010. The Mutual Funds in our Mutual Fund Portfolios are chosen from our Best Mutual Funds. The ETF’s in our ETF Investment Portfolios are chosen from our List of 100 Best Exchange Traded Funds. The investment performance history of our mutual fund portfolios and ETF investment portfolios are tracked on our investment portfolio performance page.

In the end, 2010 was a good year for investors, even though the rollercoaster they call the global financial markets occasionally looked like it was going to fall off the tracks. While the European debt crisis led many investors to believe that world economies were setting up for the much feared double dip, governments around the world continued to take action to prevent that from happening. The result was a surge in commodities prices with gold surging to record highs and oil topping $90 a barrel for the first time in two years.

While all areas of the stock market performed well, the best place to be was Small Cap Growth Stocks which added 17.1% for the quarter, and 29.1% for 2010, almost twice as much as the 15.1% returned by Large Cap Stocks. International Stocks bounced back from the effects of the Eurpoean credit crisis with an 8.1% gain this quarter, accounting for almost all of their 9% return this year. Emerging Markets Stocks continued to perform well this year with a return of 18.9% for the year.

Bonds, on the other hand, had a difficult quarter. When the FED announced that it would continue to buy billions of dollars worth of long-term Treasuries in an effort to keep interest rates low to stimulate the economy stocks celebrated the news. Unfortunately for bond holders this may have signaled the beginning of the end of a 20 year bull market in Bonds. The Bond Market actually reacted by driving up interest rates resulting in a significant fall in bond values. As is always the case with Bonds, the longer the term, the steeper the fall. To illustrate the impact of this change in market environment for debt securities, Long Term Treasuries lost 8.2% in the 4th quarter, but still managed to gain 9.4% for all of 2010. Bonds in general, however, lost only 1.3% this quarter, returning 6.5% for the year. While the net results for bonds were not bad in 2010, the way they finished the year is a clear indication that we are going to have to take some action on the bond side of our portfolios.

Investment Returns December 2010