Funds Outside the Recommended Portfolios

I’m one who remembers August 1982 when the bear market became a bull market. I also remember the turns from the market bottoms in 1987 and 1991 and from the stagnant market in 1994. Many of you were with me during the recoveries of 1997 and 1998. Each time, there were doubts about the future of the markets, and strong arguments were marshaled to explain why stocks would stagnate for years. Each time, the markets recovered and rewarded investors.

Every market bottom is different from the others. Be skeptical of analysts who forecast which signs will indicate that the market has turned or will turn. A turn in the markets catches almost everyone by surprise. In addition, a most bull market gains are concentrated in short periods of time. Some studies show that as much as 80% of stock market gains occur in just a few strong days.

That’s why I recommend that a portion of your investments always be invested in a Core Portfolio. It also is why we don’t spend much time holding a lot of cash in the Managed Portfolios. We don’t want to miss the sharp gains off the market bottoms. We reduce risk by searching for undervalued assets and selling overvalued assets. We also carefully select the mutual funds that invest our money. We are biased toward funds with experienced managers who have the discipline to follow the same investment approach successfully for years, even when the market is favoring other approaches.

A market bottom tends to be a process. The sharp bounces off the bottoms in 1997 and 1998 were unusual. More often, the stock markets slowly decline then meander in a narrow trading range before starting a bull market. Slowly, investors get disenchanted with the market until there are no more big sellers of stock and there are long-term value-oriented buyers interested in snapping up opportunities.

One bright spot is that some of my favorite fund managers are saying encouraging things in their semi-annual reports. (Good managers also tend to write good shareholder letters in their reports.)

The folks at Longleaf Partners report that they are finding more values than they have in some time. Even better, the values they place on companies generally are increasing. The economy and profits are growing while stock prices are stagnating or declining. That’s a prescription for good stock profits down the road. “The rare combination of lower prices and growing values is something we cherish,” say the Longleaf managers.

Our friends at Tweedy, Browne also see things they like in the markets.

In a special letter to shareholders, the management team wrote: “The current stream of negative news and declining stock prices will eventually run its course. In the meantime, a lot of good companies are getting to be quite cheap. This is presenting opportunities we have not seen in a long time…With each passing day, we are more and more in the ‘stocks are good values’ camp.”

These managers were saying quite the opposite in the late stages of the bull market. Then, these experienced, safety-first managers said that they could find few stocks that met their buying criteria and worried that stock values generally were too high. They were correct then, and I suspect they are correct now.

This is a good time to be sure you are fully invested according to my recommendations. We shifted the portfolios last month to match current valuations and the outlook for the next one to three years.

Since I expect relatively modest returns from U.S. stocks in the near future, we are diversified in addition to our U.S. value stocks. I recommend international bonds and stocks for the first time in years to profit from a steady decline in the dollar over the next year or so and also to profit from bargains in foreign stocks.

I also recommend high-yield bonds and corporate bonds. The interest rates on these bonds could very well equal or exceed the returns on stocks in the next year or two. As the health of the economy improves we also should earn capital gains.

My recommended funds are my top choices in the different investment categories. I also offer a list of “Other Funds To Consider” on page 11. Some readers want to invest in more than one fund in some categories. Other readers are unable to invest in my top choices because they use a broker who is not able to purchase one or more of the funds or the minimum investment is too high.

There are a number of U.S. stock funds to consider in addition to my top choices. (Schroder U.S. Smaller Companies recently changed its name to Schroder Opportunities. I’ll be watching to ensure its investment approach doesn’t change.)

Those who cannot invest in TCW Galileo Mortgaged-Backed Securities can invest in Vanguard GNMA. American Century GNMA also is a good choice, though it is not on the page 11 list.

There also are several high yield funds to consider. My favorite is Columbia High Yield. It avoided many of the technology and telecommunications bonds that hurt most other high yield funds. Vanguard High Yield is another that takes much less risk than the competition. A third choice is Northeast Investors Trust. This fund is not always fully invested in high-yield bonds and tends to buy the most beaten down bonds in which it can find value. It generally takes more risk than the other two but over time has generated a higher return.

Last month I recommended a position in the unique American Century International Opportunities. This small, young fund buys shares of stock in small companies outside the U.S. with rapidly accelerating earnings. Small stocks tend to do very well coming out of bear markets and recessions, and small, international stocks should benefit from the steady decline in the dollar.
In the last year the fund has returned over 15% to investors. The fund has a minimum $10,000 initial investment (even for IRAs) and a 2% redemption fee for shares held less than 180 days. It is difficult to buy except directly through American Century or through Charles Schwab & Co.
My first choices as substitutes now are closed to new investors, Oakmark International Small Cap and American Century International Discovery.

For investors who need an alternative, I recommend Tocqueville International Value or Driehaus International Discovery. The Tocqueville fund has a minimum investment of $1,000 and a very good record. The fund has lagged International Opportunities the last year, because it buys value stocks instead of those with growing earnings. Tocqueville is likely to be less volatile. The fund has returned over 6% in the last year and over 21% in the last six months. It has a 1.5% redemption fee for sales within 90 days of purchase.

The Driehaus fund invests in small growth stocks and has a $10,000 minimum for non-IRAs. Though it has not done as well as the American Century fund, it has a positive return of 6.11% for the last year. It has a 2% redemption fee for shares sold within 60 days.

I don’t know exactly when the bear market will end. I do know this is a good time to be sure your portfolio is positioned for a change.