How The Experts Would Divvy Up Your Portfolio
These days, finding just the right recipe for your portfolio can be tough. Just ask any asset allocator. Bond mavens can't agree whether the Federal Reserve's next move will be toward tighter or looser credit. Asia's economic crisis is roiling many stock markets around the world. And the big question is how much vigor U.S. equities have left after three straight years of 20%-or-better returns.
The idea behind asset allocation is simple: You build a diversified portfolio from an optimal mix of stocks, bonds, cash, and perhaps other assets. If you do it right, you should be able to earn a decent return with less risk. Your cash and bonds, for example, should give you protection if your stocks decline.
To help you find the right mix in these tougher times, BUSINESS WEEK called on a panel of successful professionals from different corners of the investment world for their recommendations. They differed in many areas. But with one exception, these pros shared an inclination to move away from domestic shares and toward overseas stocks. Many equities have been beaten down to bargain levels in Asia. Others may reflect prospects for more robust economic growth in some countries overseas. "It's important to take money out of U.S. markets when appropriate," advises J.P. Morgan & Co. Managing Director Jean L.P. Brunel.
BUSINESS WEEK asked each allocator how to invest a taxable account for an individual who needed neither the capital nor the dividends for basic living expenses. Because individual investors put their money to work with different aims, the experts
were asked to think both short term--for someone with a one-year investment horizon--and long term--for an investor who is thinking about returns five years down the road (table). Here's what the pros suggested:
JEAN L.P. BRUNEL, J.P. Morgan & Co. managing director: The chief investment strategist for J.P. Morgan's wealthy private clients also sees no reason to fear higher interest rates. "The biggest risk in the world is continued disinflation," he says. "Companies tell us every day that they have very limited pricing power."
Given that, Brunel suggests some intriguing fixed-income investments in what he calls the "extended market"--international, emerging-market, and high-yield bonds. Of these, "the greatest amount of value is in emerging-market debt," he says. Asia's currency mess has knocked them off their highs of recent months, and they once again sport attractive yields when compared with U.S. Treasuries. "The spreads are much too wide for the reality of the risk," he says. Such riskier fixed-income assets would claim 10% of Brunel's one-year portfolio, and perhaps 12% of the long-term one.
In equities, Brunel favors Europe, Australia, and New Zealand over the U.S. In Europe, Brunel sees expanding economic activity. He is especially fond of Singapore, which he argues has been unfairly tarred in the Southeast Asian debacle. Says Brunel: "The value is there, and you've got to step up to the plate."
MARK A. KELLER, head of managed accounts for A. G. Edwards & Sons: Among retail brokers, Edwards has earned a reputation for some of the consistently best stock research around. Small surprise, then, that Keller came up with the most stock-laden portfolios. For the one-year investor, he would put 60% in stocks, with $45,000 in the Putnam Fund for Growth & Income, $7,500 in the Templeton Foreign Fund, and $7,500 in the Goldman Sachs Small Cap Value Fund. The next 30% he would put in a municipal-bond fund, such as Colonial Tax-Exempt A, and the remainder in a tax-free money-market fund. (Each of these funds levies a sales charge, so stingy do-it-yourselfers might look for comparable no-load funds.)
Over the five-year period, Keller thinks that $72,000 should be divided evenly among 18 large- and mid-cap U.S. equities, such as Texaco Inc. and Mid Ocean Ltd. Next, he would place $12,000 apiece in the Goldman Sachs and Templeton funds. Keller is staying clear of bonds and would put just $4,000 in a money fund. Why the caution on bonds? Citing a tight job market, high factory use, and lots of cash in consumers' pockets, Keller argues that "the next meaningful move in rates is up."
BRIAN MCMAHON, president of Thornburg Management Co.: McMahon has one of the longest-running high-return, low-risk records among municipal-bond fund managers. Understandably, he has a predilection for munis--where he would put 80% of a one-year portfolio--specifically in a fund of AA credit quality and short average maturity of one to five years. But McMahon also oversees equity investments, and he has a taste for reasoned risk. He would put the balance in a closed-end fund that's devoted to Asian stocks, such as the Korea Fund or Templeton Dragon. (He thinks that over five years, the region will recover.)
For a five-year investor, McMahon sets his stock-bond allocation by age, arguing that older investors should have more fixed-income instruments whose price is cushioned by their income. If you're 45, he thinks you should put 45% in a AA muni-bond fund with an average maturity of 5 to 10 years. The rest of the money would be divided in thirds. One part would go into domestic value stocks--but not an index fund based on the Standard & Poor's 500-stock index. The other two would be allocated to Asia, Europe, and South America, where he likes "the restructurings going on." Abroad, McMahon would rely on closed-end equity funds selling at discounts and boasting good portfolio-management records.
ERNEST M. ANKRIM, director of portfolio research for Frank Russell Co.: Ankrim, who works for the world's largest pension-fund consultant, assembled the most conservative portfolios and disclaims any ability as a market timer. That said, he doesn't mind putting 30% of his one-year portfolio into an intermediate-term municipal-bond fund of AA credit quality. "It's hard for me to imagine a really sudden upspike in interest rates," he says. With the balance of this short-term portfolio in a tax-free money-market fund, rates would have to surge at least one and a half percentage points for it to lose principal in a year's time.
Ankrim's long-term portfolio is bolder, with half in stocks. He reckons that the portfolio has a 50-50 chance of returning at least $142,000 before taxes over five years--a 7.25% gain. He figures it has less than a 5% chance of losing money, given the assumptions about average annual returns on stocks (10.5%) and bonds (6.5%) that Russell uses in constructing pension funds for such clients as AT&T. Most investors, he adds, will want to use tax-free municipal money-market funds for their cash allocation, unless their combined state and federal tax rate is 28% or less. In such cases, they would do better after taxes with a taxable money fund.
AN EXOTIC APPROACH. For a different approach to asset allocation, we turned to Michael B. Orkin, manager of the Caldwell & Orkin Market Opportunity Fund. The little-known, $135 million fund has succeeded better than any of the 30 other asset allocation funds with five-year records, averaging a 19.6% average annual return, according to Value Line Inc. To do that, Orkin employs a fairly exotic strategy: a "long-short" portfolio of stocks.
Orkin bets that the risk in the fund's equity holdings is offset by short sales of stocks in other sectors that he thinks are overvalued. The fund profits when the shorted stocks fall in value, offsetting losses on the long side. This is the way lots of hedge funds for wealthy investors work, only Orkin uses no leverage. His favorite longs include high-tech and oil-service issues including Diamond Offshore. He has shorted several "subprime" lenders that do business with consumers with lower credit ratings.
In a one-year portfolio, he would allocate 10% to two high-grade muni funds, one with an average maturity of 7 to 10 years and the second, 15 to 20 years (or comparable-term taxable funds for investors with low tax rates). The balance he would invest in a 50%-long, 50%-short equity portfolio, keeping cash proceeds from the short sales in a money fund. If the market moved steadily higher in January, he would tilt his portfolio's balance toward more shorts. For a five-year portfolio, he would keep the same allocation, except to substitute long positions in Japanese blue chips for the 10% muni-bond portion of the one-year portfolio. In five years' time, Orkin expects an investor could "make some real money in Japan."