By Shefali Anand
Divergent market moves and concerns about higher interest rates ahead are two of the factors that have propelled some financial advisers to tweak their clients’ portfolios in recent months.
Some advisers have trimmed clients’ holdings of U.S. stocks in the wake of last year’s rally, particularly small-company stocks, either because they find them too expensive or because recent gains have pushed clients’ holdings beyond the target allocation the advisers want to maintain. Meanwhile, some have reduced their holdings in longer-term bonds, which would be hurt if interest rates rise.
Many advisers have added foreign stocks, particularly those of emerging markets, which fared poorly last year. The MSCI Emerging Markets Index fell 5% in 2013. “Over the long term [emerging markets] are going to be the fastest-growing economies,” says Ross Levin, president of Accredited Investors Inc., an Edina, Minn., firm that manages $1.4 billion in assets.
In this column, we present model portfolios from prominent financial advisers who invest in mutual funds and exchange-traded funds. We reconnected with Mr. Levin and advisers from three other firms we featured in the past to see how they’re positioning their portfolios based on expectations for 2014.
Here are their views:
Ross Levin: Accredited Investors
Since June, Mr. Levin has cut the allocation to small-company U.S. stocks for a client who can handle moderate risk by two percentage points, to 12% of the portfolio. He believes these stocks have become expensive, with the Russell 2000 Index recently trading at around 30 times the one-year earnings of the underlying companies.
On the other hand, Mr. Levin finds that emerging-markets stocks are relatively cheap. The MSCI Emerging Markets Index was recently trading at a price/earnings ratio of around 12. He increased the overall allocation to foreign stocks by two percentage points to around 21%. Within this, emerging markets get around 4.5% of the portfolio, up from 3%.
In the portfolio’s 33% bond allocation, Mr. Levin has trimmed his overall holding of medium- to long-term bonds, which would lose value when interest rates rise. But he has doubled his clients’ investment to 7% of the portfolio in the BlackRock National Municipal fund, which invests in medium- to long-term municipal bonds, because he believes muni bonds offer better after-tax yields than taxable bonds right now.
Mr. Levin invests 13% of the portfolio in two nontraditional funds that he expects will hold up in poor stock and bond markets—JPMorgan Stategic Income Opportunities and AQR Diversified Arbitrage.
Given that clients have made a lot of money in the past few years, “we’re in a situation now where we want to make sure they keep what they’ve earned,” says Mr. Levin.
Cheryl Holland: Abacus Planning Group
Cheryl Holland, founder of Abacus Planning Group Inc. in Columbia, S.C., says her firm increased clients’ exposure to emerging markets to 8% of the total from 6%, in a belief that they will benefit as the U.S. economy gains strength in 2014.
The firm also increased the allocation to small companies in developed foreign countries by two percentage points, to 7%. “The valuations looked so good to us,” says Ms. Holland, whose firm manages around $800 million in assets. The overall foreign-stock allocation is now at 27%, and the same percentage goes to U.S. stocks overall.
Within the 30% bond allocation, Ms. Holland has removed an investment in riskier high-yield and emerging-markets bonds. She says both sectors are expensive. She has also reduced her investments in long- and medium-term bonds.
In 2013, Ms. Holland also cut to 8% from 10% an allocation to funds that aim to lose less value when stocks fall, partly by betting against stocks. As the stock market gained value in 2013, these funds generated lower returns than the broad market. “It’s become a very expensive strategy,” she says.
She still holds these “hedging strategy” funds to protect against unforeseen volatility in coming months. Ms. Holland says that if unemployment in the U.S. rises or corporate earnings aren’t as strong as people expect them to be, “that will give everybody pause about where the market is.”
Leo Marzen and Milton Stern: Bridgewater Advisors
The team at Bridgewater Advisors Inc. in New York is increasing clients’ allocation to foreign developed countries, primarily European nations and Japan. “Those economies also seem to have turned a corner” and that will ultimately boost their stock values, says Leo Marzen, a founding partner of the firm, which manages around $1.2 billion in assets.
For clients who can handle moderate risk, Bridgewater advisers are raising the allocation to foreign developed-country stocks to 19%, up from 12% in December. An additional 8% is invested in an emerging-markets stock fund. The advisers are cutting the U.S.-stock allocation to 20% from 23% in December.
Like others, Bridgewater advisers have cut the allocation to medium-term bonds and inflation-protected bonds. It’s now “difficult to earn a real return in bonds, after taxes and inflation,” says Mr. Marzen.
Instead, they added to their investment in a real-estate mutual fund, bringing it to 5%. They also bought Avenue Credit Strategies, which invests partly in high-yield bonds, short-term bank loans and distressed debt. Mr. Marzen says that although these bonds have become expensive, he believes that Avenue managers will “still be able to find decent opportunities.”
Last year the advisers also bought Gotham Absolute Return, which aims to make money partly by betting against stocks. The advisers have a 30% allocation to what they call “strategic” funds like Avenue and Gotham, which they expect to either hold up better than the average stock fund during a downturn or provide higher yields.
“The search for yields continues,” says Milton Stern, co-founder of Bridgewater.
Michael Chasnoff and Steve Condon : Truepoint
Advisers at Truepoint Inc. say investors shouldn’t be making changes in their portfolios based on forecasts of how stocks, bonds and other assets will perform this year. “You do not need an accurate forecast…in order to be a successful investor,” says Michael Chasnoff, founder and chief executive officer of the Cincinnati firm, which manages around $1.5 billion.
Instead, Mr. Chasnoff says investors should systematically rebalance their portfolios, selling investments that have gained value and buying what has lost value, to bring them back to target allocations. In 2013, Mr. Chasnoff cut clients’ allocation to U.S. stocks, especially small stocks, which had risen far beyond their target allocation. The current U.S.-stock allocation is 38% for a moderate-risk portfolio.
The money was reinvested into emerging markets and real estate, which were “among the worst performers” in 2013, says Steve Condon, managing principal at the firm. The advisers believe that over long periods, assets typically swing back to their long-term average return.
The overall foreign-stock allocation stands at 25%, while real estate gets a 7% investment. Bonds get a 27% allocation, and the remaining 3% is kept in cash, to be used to cover clients’ near-term spending needs.
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Ms. Anand is the markets and finance editor for The Wall Street Journal in India. Email: email@example.com.