News Analysis BusinessWeek.com April 26, 2006 Link
AARP Funds: Not Necessarily Golden
The advocacy group for retirees has unveiled three mutual funds of its own. But it faces stiff competition
One of the best-known names in retirement now offers a way of getting there. AARP, the membership and advocacy group for people age 50 and older, recently launched its own mutual fund family. AARP's three new funds aim to make it easy and inexpensive to save up for one's golden years. Though the funds could attract some investors with their low costs and investment minimums, other products may offer greater returns down the road.
AARP Conservative Fund, AARP Moderate Fund, and AARP Aggressive Fund are the latest in a wave of investment products that do investors' asset-allocation work for them (see BW, 4/25/05, "A Nest Egg That's a No-Brainer"). "It's a much simpler way to invest, because you get an instant portfolio in one purchase," says Nancy Smith, vice-president of investment services for the newly formed AARP Financial, based in Tewskbury, Mass. The funds are subadvised by a subsidiary of exchange-traded fund giant State Street Global Advisors and distributed by Denver-based ALPS Distributors.
REPLACING SCUDDER. AARP Financial isn't the group's first move into the mutual fund industry. For more than 20 years, AARP allowed Scudder Investments (currently owned by Deutsche Asset Management, which recently changed the fund unit's name to DWS Scudder) to offer a special no-load class of its funds to AARP members. This relationship ended Dec. 31, 2005, as AARP readied its own offerings.
The new AARP funds spread assets across three underlying portfolios of stocks, bonds, and other securities. They mimic the MSCI U.S. Investable Market 2500 index for U.S. stocks, the MSCI EAFE index for international stocks, and the Lehman Brothers Aggregate Bond index for U.S. bonds. The funds rebalance regularly to match a certain risk-tolerance level.
Investors poured $30.8 billion into similar asset-allocation offerings last year, according to Boston-based Financial Research Corp. (FRC), and assets in such funds have jumped from $54.5 billion at the end of 2002 to $143.5 billion at the end of 2005.
The AARP funds boast relatively competitive pricing, but there are cheaper options. Each AARP fund carries an expense ratio capped at 0.5% through Nov. 1, 2007. Still, the comparable Vanguard LifeStrategy Moderate Growth Fund (VSMGX ) charges only 0.25%. That fund also includes an active element, investing 25% of its assets in Vanguard Asset Allocation (VAAPX ). The actively managed Fidelity Asset Manager: Growth (FASGX ) is a bit costlier at 0.82%, but Fidelity Four-in-One Index (FFNOX ) has a 0.21% price tag.
EASY ENTRY. Low investment minimums mean even investors without much spare cash can start socking away for retirement. The AARP funds require an initial investment of at least $100. Investors contributing through an automatic investment program can get started for as little $25, Smith says. By comparison, the Vanguard LifeStrategy funds have an initial investment minimum of $3,000 for most accounts, and the Fidelity Asset Manager funds call for $2,500.
However, simplicity may come at a cost, analysts say. The AARP funds don't currently invest in emerging-markets stocks, though the prospectus permits them to do so as the funds grow. "They could be potentially leaving some returns on the table," says Philip Edwards, managing director of Standard & Poor's Investor Services. Nor do the funds address retirees' need for current income, he says. AARP's Smith says the group may develop an income product down the road.
The funds also face competition from even simpler offerings (see BW Online, 2/24/06, "Jump-Start a Lifetime of Saving"). "This kind of portfolio is not where the money's at right now," says Lipper research analyst Jeff Tjornehoj. Target-date funds -- "one-stop shopping" portfolios that automatically grow more conservative as they approach a certain retirement date -- have been gaining ground on funds like AARP's, which remain static. Assets in target-date funds nearly doubled in 2005, rising to $70.1 billion from $43.8 billion at the end of 2004, according to FRC.
Meanwhile, AARP's foray into index-based investing comes as the indexing world has been trimming fees. "It could be difficult for them to gain much headway given all the competition out there, especially on the price side," says Morningstar (MORN ) fund analyst Greg Carlson. Industry heavyweights Fidelity and Vanguard traded fee cuts on their index funds throughout 2005.
REACHING CUSTOMERS. Another challenge for AARP will be selling the funds to the millions of investors who work with a financial intermediary, fund watchers say (see BW Online, 4/8/05, "Finding the Right Money Coach"). "The ranks of the do-it-yourselfers have steadily decreased over the last 10 years," says Jeff Keil, principal at industry consultancy Keil Fiduciary.
Even the simplest funds may prompt questions, AARP's Smith acknowledges. Investors can speak with salaried phone representatives for guidance as they decide whether to put assets in the funds.
AARP plans to promote the funds through direct mail, telephone calls, and eventually media advertising, she says, and the products are available to anyone, not just the group's 35 million members. Though AARP has the marketing power, mutual funds may be one area that's tough to crack.
The Dow reached a six-year closing high after Merril Lynch upgraded its rating on the giant automaker. Boeing, Colgate-Palmolive and PepsiCo posted higher profits
Stocks finished higher Wednesday, supported by solid corporate earnings and an analyst upgrade of General Motors (GM ). Investors shrugged off the Federal Reserve's Beige Book report, after weathering inflation fears fanned by surges in March durable goods orders and new home sales, says Standard & Poor's Equity Research.
The Dow Jones industrial average climbed 71.24 points, or 0.63%, to 11,354.49, a six-year closing high. The broader Standard & Poor's 500 index rose 3.68 points, or 0.28%, to 1,305.42. The tech-heavy Nasdaq composite gained 3.33 points, or 0.14%, to 2,333.63.
Investors were responding Wednesday to upbeat General Motors (GM ) news. The automaker was higher after Merrill Lynch raised its recommendation on the stock from sell to neutral.
A new set of economic data was also in focus. The Fed's Beige Book said the economy continued to expand, but held mixed messages on inflation, says S&P Equity Research.
Still, the Beige Book did little to change expectations of future interest rate hikes, some analysts say. "There's nothing here that jumps out as being anecdotal evidence of a picture materially different than what the data have suggested," says Keith Hembre, chief economist at First American Funds. "We pretty much remain in the data-driven situation with regard to Fed moves."
Federal Reserve Chairman Ben Bernanke is set to testify before the House of Representatives Joint Economics Committee on Thursday, with first-quarter gross domestic product (GDP) and employment cost index (ECI) out on Friday.
Some analysts say they expect Bernanke's testimony to be upbeat on the economy but skimpy on rate clues. "Among the issues he's likely to center on are the importance of lags from past tightening, risks of overshooting, Bernanke's assessment of inflation prospects in the wake of a higher-than-expected CPI for March, and how he thinks about renewed energy price pressures," says Edward McKelvey, senior economist at Goldman Sachs.
In other economic data Wednesday, new home sales surged 13.8% to a 1.2 million units in March, well above expectations, says Action Economics. Durable orders in March jumped 6.1%, also handily topping forecasts.
Investors were also sifting through earnings reports. Toothpaste seller Colgate-Palmolive (CL ) and soft-drink maker PepsiCo (PEP ) were all higher after posting increases in first-quarter profits, while aerospace contractor Boeing (BA ) was modestly lower.
In the oil industry, ConocoPhillips (COP ) was lower despite its own first-quarter profit increase. Exxon Mobil (XOM ) posts quarterly results Thursday, followed by Chevron (CVX ) on Friday.
Other companies due to report earnings Thursday include Aetna (AET ), Bristol-Myers Squibb (BMY ), Gateway (GTW ), Raytheon (RTN ) and XM Satellite Radio (XMSR ).
Elsewhere Wednesday, telecom conglomerate AT&T (T ) rose on news the company will offer a movie delivery services to its high-speed Internet subscribers.
Online retailer Amazon (AMZN) was higher after the company said its sales may rise to $10.5 billion and profit excluding items may increase to $520 million in 2006.
On the M&A front, software giant Microsoft (MSFT) reportedly will announce next week an acquisition of privately held ad-placement company Massive, in a deal valued at $200 million to $400 million.
Meanwhile, electronics maker Sanmina-SCI (SANM) was sharply higher after the company issues an earnings forecast for this quarter that exceeded the estimates of some analysts.
In the energy markets Wednesday, June West Texas Intermediate crude oil futures closed down 95 cents at $71.93, after a weekly inventory report showed a modest decline of 200,000 barrels.
European markets finished modestly higher. In London, the Financial Times-Stock Exchange 100 index rose 17.7 points, or 0.29%, to 6,104.3. Germany's DAX index bounced 28.32 points, or 0.47%, to 6,107.12. In Paris, the CAC 40 index was up 16.98 points, or 0.32%, to 5,252.32.
Asian markets finished higher. Japan's Nikkei 225 index rose 85.64 points, or 0.5%, to 17,055.93. In Hong Kong, the Hang Seng index added 94.89 points, or 0.57%, to 16,672.66. Korea's Kospi index climbed 20.07 points, or 1.4%, to 1,451.22.
Treasury yields climbed in the wake of the strong durable goods report. Prices for 10-year Treasury notes fell to 95-11/32 with a yield of 5.11%, while 30-year bonds dropped to 89-22/32 for a yield of 5.18%.
Dollar weakness weighed on equities. Earnings from AmEx and Caterpillar were also in focus
Stocks finished modestly lower Monday, as investors digested mixed earnings reports and a drop in the dollar against the yen after the G7 nations called for China to let its currency appreciate. Dollar weakness supported a shift out of U.S. equities and a safety bid in Treasuries, says Standard & Poor's Equity Research.
The Dow Jones industrial average edged lower 11.13 points, or 0.1%, to 11,336.32, weighed down by weakness in General Motors (GM ) and Merck (MRK ) despite gains from Disney (DIS ). The broader Standard & Poor's 500 index slipped 3.17 points, or 0.24%, to 1,308.11. The tech-heavy Nasdaq composite lost 9.48 points, or 0.4%, to 2,333.38.
Earnings season has brought some price-to-earnings surprises, some analysts say. "Recent earnings news is good, and fewer companies are talking down their profit forecasts," says Thomas McManus, chief investment strategist with Banc of America Securities. "Even so, we are surprised that P/E multiples remain robust for what we see as cyclically enhanced earnings."
Investors were eyeing earnings news Monday. Construction equipment maker Caterpillar (CAT ) was modestly lower after reporting a 45% jump in first-quarter profit. Fellow Dow component American Express (AXP ) dipped after the financial services company posted a 8% decline in first-quarter profits, slightly better than expected.
Tech bellwether Sun Microsystems (SUNW ) was also set to announce quarterly results Monday. Oil giants Chevron (CVX ), Exxon Mobil (XOM ) and ConocoPhillips (COP ) come up later in the week.
Elsewhere in earnings, copier maker Xerox (XRX ) was sharply lower after posting first-quarter profit that missed analysts' estimates. Toy maker Hasbro (HAS ) was lower after posting a wider first-quarter loss.
In M&A activity, Washington Mutual (WM ) was lower after the bank agreed to acquire Commercial Capital Bancorp (CCBI ) for $983 million.
Cendant (CD ) was higher as the company said it would consider selling its travel distribution services division.
The economic calendar was quiet Monday. Investors were looking toward Federal Reserve Chairman Ben Bernanke's JEC testimony, set for Thursday. The week's docket also includes existing and new home sales, durable orders and consumer confidence, with first-quarter gross domestic product (GDP) and employment cost index (ECI) out on Friday. Meanwhile, the Fed's Beige Book Wednesday could foreshadow the chairman's remarks, says Action Economics.
In the energy markets, June West Texas Intermediate crude oil futures closed down $1.84 at $73.33. Profit-taking and hedge fund selling drove the decline, says S&P Equity Research.
European markets finished lower. In London, the Financial Times-Stock Exchange 100 index fell 34 points, or 0.55%, to 6,098.7. Germany's DAX index edged lower 15.66 points, or 0.26%, to 6,079.09. In Paris, the CAC 40 index dropped 30.94 points, or 0.59%, to 5,221.44.
Asian markets finished sharply lower. Japan's Nikkei 225 index tumbled 489.56 points, or 2.81%, to 16,914.4. In Hong Kong, the Hang Seng index fell 206.48 points, or 1.22%, to 16,705.67. Korea's Kospi index slid 20.37 points, or 1.4%, to 1,430.94.
Prices for 10-year Treasury notes rose to 96-09/32 with a yield of 4.99%, while 30-year bonds climbed to 91-11/32 for a yield of 5.06%.
Investors digested a narrower-than-expected trade gap and solid profits from Circuit City, while Treasury yields neared multi-year highs
Stocks finished modestly higher Wednesday, as a smaller-than-expected trade deficit and some upbeat earnings reports outweighed higher Treasury yields. Near-term oversold conditions and generally bullish earnings sentiment supported equities, says Standard & Poor's MarketScope.
The Dow Jones industrial average rose 40.34 points, or 0.36%, to 11,129.97. The broader Standard & Poor's 500 index added 1.55 points, or 0.12%, to 1,288.12. The tech-heavy Nasdaq composite was up 4.33 points, or 0.19%, to 2,314.68.
World markets were reacting cautiously Wednesday to reports Iran intends to move toward large-scale nuclear programs, says S&P MarketScope. The U.N. wants those programs halted, and Washington is reportedly considering plans to use tactical nuclear weapons against Tehran.
Investors were also digesting a fresh dose of economic data. The U.S. trade deficit narrowed to $65.7 billion in February from $68.6 billion in January. That's narrower than expected and boosts forecasts for first-quarter economic growth, says Action Economics.
Electronics retailer Circuit City (CC ) was higher in afternoon trading after posting 65% higher profit for its fiscal fourth quarter. Newspaper publisher Gannett (GCI ) was lower after posting an 11.5% first-quarter earnings decline.
Also in earnings, drugmaker Genentech (DNA) was lower after reporting 48% higher first-quarter profit late Tuesday. The company said first-quarter U.S. sales of its leading cancer drug were less than expected.
Chipmaker Advanced Micro Devices (AMD ) was set to report quarterly results after the closing bell. Industrial giant General Electric (GE will post earnings Thursday.
Elsewhere, General Motors (GM ) led the Dow higher after the automaker said it had record sales in China last year and will boost sales of its Chevrolet-brand cars by at least 50% this year. Rival DaimlerChrysler (DCX ) was little changed after its CEO projected higher 2006 profits.
Of other blue-chips in focus, aerospace contractor Boeing (BA ) was higher on news of a $5.3 billion aircraft contract with China.
Wireless phone maker Motorola (MOT ) was higher after Bear Stearns boosted the stock from peer perform to outperform.
In deal activity, Tivo (TIVO ) rose on news of a three-year extension to the company's commercial agreement with satellite TV provider DirecTV (DTV ).
Investors will have economic data to consider Thursday ahead of the long weekend. The docket includes February business inventories, March retail sales, March import prices and April consumer sentiment, along with weekly jobless claims.
In the energy markets Wednesday, May West Texas Intermediate crude oil futures closed down 36 cents at $68.62 after weekly inventory data showed an unexpectedly large supply increase.
European markets finished modestly lower. In London, the Financial Times-Stock Exchange 100 index fell 15.7 points, or 0.26%, to 6,000.8. Germany's DAX index was off 7.22 points, or 0.12%, to 5,901.25. In Paris, the CAC 40 index dropped 27.49 points, or 0.54%, to 5,085.11.
Asian markets finished lower. Japan's Nikkei 225 index tumbled 255.58 points, or 1.47%, to 17,162.55. In Hong Kong, the Hang Seng index fell 165.05 points, or 1%, to 16,310.76. Korea's Kospi index slipped 2.49 points, or 0.18%, to 1,383.59.
Prices for 10-year Treasury notes were lower at 96-11/32 with a yield of 4.97%, while 30-year bonds fell to 91-20/32 for a yield of 5.05%.
The Iranian president said the country was producing enriched uranium. Meanwhile, crude futures hit a seven-month high
Stocks finished broadly lower Tuesday, as Iran news and rising commodity prices offset upbeat quarterly results from Dow component Alcoa (AA ). Treasury yields remained near recent peaks amid ongoing inflation concerns, says Standard & Poor's MarketScope.
The Dow Jones industrial average fell 51.7 points, or 0.46%, to 11,089.63, trailed by Verizon (VZ ). The broader Standard & Poor's 500 index dipped 10.04 points, or 0.77%, to 1,286.56. The tech-heavy Nasdaq composite skidded 22.92 points, or 0.98%, to 2,310.35.
A flurry of gloomy news dampened sentiment Tuesday, after an initial advance. "There are multiple negative catalysts to the market today," says Art Hogan, chief market analyst at Jefferies & Co. "You throw all that together and the market isn't going to be rejoicing."
Markets were weighing geopolitical news Tuesday. Iranian President Mahmoud Ahmadinejad announced that Iran had successfully enriched uranium, following similar remarks by former Iranian President Hashemi Rafsanjani. Separately, U.S. President George W. Bush dismissed reports his administration was preparing plans for air strikes against Iran as "wild speculation."
For a second straight day, the calendar was light on economic data. Investors will get a fresh helping Wednesday with the release of the February trade deficit. Action Economics forecasts a reading of $68.2 billion, but says investors may be in for a surprise, as other projections vary widely.
Financial heavyweights Merrill Lynch (MER ) and Goldman Sachs (GS ) were lower Tuesday after a Merrill analyst, two Goldman employees and a worker at a plant that printed Business Week were charged in a $6.7 million insider-trading scheme.
Meanwhile, Merck (MRK ) was lower after a jury added $9 million to the damages the drugmaker must pay related to its Vioxx painkiller.
The session kicked off with solid earnings news. Aluminum giant Alcoa (AA ) was higher after late Monday posting first-quarter profit that nearly doubled, beating analyst estimates. Drugmaker Genentech (DNA ) is on deck after the closing bell.
Chipmaker Micron Technology (MU ) was higher after reporting a 64% increase in second-quarter profit, despite a 6.3% drop in sales.
Later in the week, rival Advanced Micro Devices (AMD ), newspaper publisher Gannett (GCI ), motorcycle maker Harley-Davidson (HDI ) and industrial giant General Electric (GE ) are among companies set to post quarterly results.
Elsewhere, Wal-Mart (WMT ) was lower after community bankers asked regulators to block the retailer's plan to expand into banking.
Automaker General Motors (GM ) was lower after selling its stake in truckmaker Isuzu for about $300 million.
Cellular phone maker Nokia (NOK ) was higher after the company said its first-quarter phone sales topped its previous forecasts.
The NASDAQ Stock Market (NDAQ) reportedly purchased a 15% stake in the London Stock Exchange for about $780 million, becoming the bourse's biggest shareholder.
On the brokerage front, Bausch & Lomb (BOL) was sharply lower after Piper Jaffray cut the stock from outperform to market perform. The contact lens maker temporarily halted shipments of its ReNu solution with MoistureLoc due to reports of fungal infections.
In the energy markets Tuesday, May West Texas Intermediate crude oil futures closed up 24 cents at $68.98, a seven-month closing high.
European markets finished lower. In London, the Financial Times-Stock Exchange 100 index fell 50.5 points, or 0.83%, to 6,016.5. Germany's DAX index was off 94.93 points, or 1.58%, to 5,908.47. In Paris, the CAC 40 index dropped 77.67 points, or 1.5%, to 5,112.6.
Asian markets finished lower. Japan's Nikkei 225 index slipped 38.45 points, or 0.22%, to 17,418.13. In Hong Kong, the Hang Seng index fell 45.78 points, or 0.28%, to 16,521.59. Korea's Kospi index sank 12.21 points, or 0.87%, to 1,386.08.
Treasury yields remained close to multi-year highs, says S&P MarketScope. Prices for 10-year Treasury notes were modestly higher at 96-22/32 with a yield of 4.93%, while 30-year bonds rose to 92-08/32 for a yield of 5%.
March payrolls rose 211,000, while the unemployment rate fell. Treasury yields closed at multi-year highs
Stocks finished sharply lower Friday, as market players weighed the government's March employment report and a rise in the 10-year Treasury yield to its highest close since 2002 stoked inflation fears. Profit-taking added to stock price weakness, says Standard & Poor's MarketScope.
The Dow Jones industrial average fell 96.46 points, or 0.86%, to 11,120.04, with Hewlett-Packard (HPQ ) leading the retreat. The broader Standard & Poor's 500 index was down 13.54 points, or 1.03%, to 1,295.5. The tech-heavy Nasdaq composite slid 22.15 points, or 0.94%, to 2,339.02.
Investors were assessing a key labor market gauge Friday. The Labor Department said nonfarm payrolls rose 211,000 in March after a downwardly revised 225,000 increase in February. The unemployment rate slipped to 4.7% from 4.8%. The data are fairly close to expectations and suggest a solid jobs market, says Action Economics.
The report comes amid concerns over Treasury yields, oil prices and the Fed, some analysts note. "This is kind of a mixed bag," says Chris Johnson, managing quantitative analyst at Shaeffer's Investment Research. "The selling is probably investors just taking profits before the weekend right now, and likely to be contained."
The underlying numbers, while strong, weren't as strong as some feared. "Overall, it's a benign report," says Brian Gendreau, investment strategist at ING Investment Management. "It looks pretty good for the economy, and it looks pretty good for the outlook for markets."
First-quarter earnings season will likely dominate investors' attention next week, with aluminum giant Alcoa (AA ) and drugmaker Genentech (DNA ) among companies set to report.
BlackBerry maker Research in Motion (RIMM ) was lower Friday after posting a fourth-quarter profit of $18.4 million, up from a net loss of $2.6 million a year earlier.
On an up note, coffee leviathan Starbucks (SBUX ) was higher after reporting 10% higher March same-store sales.
Automakers were also in the news. General Motors (GM ) was modestly lower despite reports its Russian sales are strong. Ford (F) was also down after rising on news its president and chief operating officer, Jim Padilla, will retire Jul. 1 after 40 years with the company.
Drugmaker Merck (MRK) was lower as a Florida lawsuit charged the company with failing to disclose that its Fosamax osteoporosis drug can cause jawbone tissue to die.
On the brokerage front, network developer Extreme Networks (EXTR ) was lower after Citigroup slashed its rating on the stock from buy to hold. Bed Bath & Beyond (BBBY ) slipped as JPMorgan Chase cut its rating on the retailer from overweight to underweight.
Elsewhere, mattress maker Sealy (ZZ ) was sharply higher in its first day of trading.
In the energy markets Friday, May West Texas Intermediate crude oil futures closed down 55 cents at $67.39 a barrel.
European markets finished lower. In London, the Financial Times-Stock Exchange 100 index fell 19.6 points, or 0.32%, to 6,026.1. Germany's DAX index tumbled 78.47 points, or 1.3%, to 5,952.92. In Paris, the CAC 40 index was down 47.4 points, or 0.91%, to 5,174.96.
Asian markets finished higher. Japan's Nikkei 225 index rose 74.04 points, or 0.42%, to 17,563.37. In Hong Kong, the Hang Seng index added 60.65 points, or 0.37%, to 16,471.78. Korea's Kospi index gained 5.36 points, or 0.38%, to 1,402.36.
Long-term Treasury yields pushed to new multi-year highs after briefly easing on the employment numbers. Prices for 10-year Treasury notes were lower at 96-14/32 with a yield of 4.96%, while 30-year bonds fell to 91-23/32 for a yield of 5.04%.
Some pros say investors aren't paying enough attention to risk. Here are some smart steps to help protect your investments
This may sound amazingly self-evident, but it's worth repeating: Investing is inherently risky. And too much risk may be hazardous to your financial health. Anyone who has ever watched a stock like Google (GOOG ) or General Motors (GM ) execute a power-dive knows how much sudden downturns can hurt a portfolio.
But unless you wish to stash your assets in the Bank of Posturepedic, you will have to take on some risk as you put your money to work. The trick is to take on the right amount for your age and your financial circumstances.
It's not always easy, especially when financial market upswings can make investors complacent. Market veterans have increasingly warned against excessive risk. Most recently, bond-fund guru Bill Gross cited a possible downside in indexes he deems overvalued. "The crash of risk assets and their return to normalcy may be hard to time, but...these periods never end well," the PIMCO chief investment officer wrote in his latest monthly outlook.
FIRE ALARM. How much risk is too much? "It's difficult to define," says Phil Edwards, managing director of Standard & Poor's Investor Services. One gauge of risk is standard deviation, which measures the volatility of a mutual fund's returns. The Standard & Poor's 500 index has a standard deviation of 17. This figure should be higher for small-caps and lower for large-caps. The number of securities in a fund and their level of liquidity also determine its risk.
Fresh risks loom as baby boomers near retirement (see BW, 7/25/05, "More Risk -- More Reward"). Retirees don't only have to worry about losing money. They've got to contend with inflation, rising health-care costs, and the chance they'll outlive their assets, too.
Not insuring against those risks "is the same as not insuring my home against fire," says John Diehl, vice-president for advanced products marketing at The Hartford. The company is one of many selling products to protect against these upcoming perils.
The biggest risk? Not saving, says S&P's Edwards. Fortunately, investors can take a few steps to make sure that their portfolios reflect a sensible degree of risk. This Five for the Money finds ways investors can steer away from the hazards on the road to financial security.
1. Act Your Age It's never too early to save. The probability a stock portfolio will lose money decreases dramatically over long periods of time, financial planners say. In other words, the sooner you start socking away, the less likely your assets will be at the mercy of the market's whims. "Time diversification is your first defense against worrying about portfolio volatility," says Ken Solow, chief investment officer for Pinnacle Advisory Group.
At the other end of the spectrum, severe declines can be disastrous for the newly retired. That's why older investors should gradually shift their assets toward less-risky investments, like bonds, financial planners say. But they caution against moving too much too soon.
Meanwhile, retirees ought to closely monitor their portfolios. "You should only really be taking annual withdrawals in the range of 4% of your total portfolio value," says Diane Pearson, director of financial planning at Legend Financial Advisors. She says some investors get into the habit of withdrawing a constant dollar amount, which each year cuts out an increasingly large portion of their portfolios.
2. Celebrate Diversity Diversify, diversify, diversify. Spreading assets across investments that move independently of each other is the most fundamental way to guard against portfolio risk. When an automotive stock is down, for instance, a health-care stock might be moving in the opposite direction.
A broadly diversified set of holdings will include many investments that tend to perform in different ways. Owning a pair of index funds like the Vanguard Total Stock Market Index Fund (VTSMX ) and the Vanguard Total International Stock Fund (VGTSX ) provides access to thousands of securities at little cost, notes Rick Miller, CEO of Sensible Financial. "Diversification is easier now than it's ever been," he says.
Naturally, some asset classes are riskier than others. A "classic" balanced portfolio of 60% stocks and 40% bonds will have greater potential downside than a portfolio of 40% stocks and 60% bonds. Within an equity allocation, investors may want to diversify between domestic and international stocks, small-cap and large-cap stocks. Financial advisers often recommend tilting stock holdings toward value, rather than growth, to further reduce risk.
3. Look Under the Hood Don't assume a portfolio is diversified just because it includes five or six mutual funds. Many funds have holdings that actually overlap. "Dig a little bit deeper," says Pearson.
Even if two funds seem to have different strategies, they may not provide true diversification. A growth fund might invest in a surprising number of value stocks, or vice versa, while a domestic fund could hold a smattering of international stocks.
Investors can learn more about funds' holdings through various financial Web sites, including Morningstar (MORN ) and Lipper. BW Online has a fund screener with this information, too.
4. Consider Alternatives A less traditional way to get further diversification is through alternative investments. Asset classes like commodities, commodity futures, and hedge funds tend to move differently from stocks and bonds. Some financial planners say alternative investments can protect investors against risk in an environment where both stocks and bonds underperform.
Owning real estate can be another way to diversify. "Many firms look at real estate as an alternative asset, but we think it's a fundamental holding," says Kevin Gahagan, a principal with Mosaic Financial Partners. He likens a portfolio to a garden, where different asset classes will be in bloom at different times.
Real Estate Investment Trusts, or REITs, and REIT mutual funds provide a liquid means of investing in real estate (see BW, 12/26/05, "After the Housing Run-Up"). But some say REITs move too much like small-cap value stocks to ward off additional risk.
5. Stay the Course Once you have a financial plan in place, stick to it. Behavioral finance suggests investors tend to make the wrong decisions at the wrong time, often for the wrong reasons. "One of the real risks to long-term portfolio success is allowing emotion and psychology to trump sound strategy," Gahagan says.
Chasing hot sectors in a bull market or fleeing from equities in a downturn may make sense at the time, but they're rarely smart financial strategies. Asset allocation shouldn't change with an investor's mood. A properly diversified portfolio at the onset of the 2000 bear market would have been out of the red before an all-equity portfolio, according to Gahagan.
Even risk-averse investors should expect to weather occasional declines. But taking a few savvy steps can increase the odds a portfolio will come out ahead.
Julius Baer Global High Yield Fund manager Greg Hopper sees rich returns in Europe and in local-currency emerging-market debt
The high-yield market offers more opportunities if you go abroad, according to portfolio manager Greg Hopper. He looks for junk bonds issued in South America and Indonesia, as well as Europe and the U.S. for the Julius Baer Global High Yield Fund (BJBHX ). "This is a global search for yield," Hopper says.
The fund has racked up benchmark-beating numbers in an increasingly challenging segment of the market, particularly with General Motors (GM ) and Ford (F ) credit entering junk-bond status (see BW Online, 1/27/06, "Tough Times in the Junk Yard"). Julius Baer Global High Yield posted three-year annualized returns of 13.9%, compared with 5.94% for its style peers and 4.97% for the Lehman Brothers Global Aggregate Bond Index.
Launched in December, 2002, the fund recently earned five stars in its first Morningstar rating. Its expense ratio, recently capped at 1%, is about average for its category. Hopper manages $240 million in global high-yield assets for Julius Baer, including the $40 million fund.
He recently spoke with BusinessWeek Online reporter Marc Hogan about his outlook and about taking an equity approach to fixed-income. Edited excerpts from their conversation follow.
The Fed finally made its move, raising rates a quarter-point and leaving the door open for more tightening. What's your take? For high-yield, interest rates don't have as much significance as for higher grade bonds. The announcement looked a little more aggressive than people were expecting. I don't think it changes the prognosis significantly.
People are expecting further Fed hikes depending on what kind of numbers we see in the economy. As the short-term rate goes up, it's hard to see how the longer-term rates don't continue going up as well.
Tell me a little about the philosophy of the fund. The world doesn't need another high-yield fund. What we decided to do was create a fund that takes a much more comprehensive view of what high-yield is. We're not just looking at what's defined as high-yield by the Wall Street underwriters and put into their indexes, which is mostly plain vanilla.
What we want to do is look beyond that and look at, for example, European high-yield. We look at emerging market bonds, both hard currency- and local currency-denominated. For example, we have in the past owned local currency government bonds of Colombia, denominated in pesos. We will look also at things like busted convertible bonds and preferred stocks, as long as they're senior to equity.
Why did European high-yield bonds fare so well last year? Partly because they're still rebounding from a horrible beginning to that market a few years ago, right in the midst of the telecom crisis. Telecom represented as much as 20% of the U.S. high-yield market at its peak. It was more like 40 or 50% in Europe.
The other aspect to Europe vis à vis the U.S. last year is that there was a lot less issuance relative to the flow of money into the market, particularly toward the end of last year.
What are you finding there now? I'm marginally more positive on Europe than I am the U.S., if for no other reason than at its doorstep is Eastern Europe. You've got Poland, and Slovakia, and more recently Ukraine, despite their political trials and tribulations. These are all tremendously promising new economies.
That brings us to emerging markets. What opportunities do you see? We haven't liked hard currency emerging-market debt for the better part of 18 months. It's very tight. Where we see opportunities is in local currency debt of places like Brazil, Columbia, and Indonesia.
What spurred the double-digit returns last year in Brazil and Turkey? A lot of these major emerging markets are beginning to reap the benefits of political and economic reform that has been taking shape over a number of years. There is a lot going on beneath the surface in terms of modernizing the tax laws, bankruptcy laws, and financial regulations.
All this has a cumulative effect. That, with a backdrop of global stability -- economic stability, at least -- has been tremendously beneficial for some of these major economies.
Let's talk about a few of your top holdings and why you like them. I can't talk too much to specific issues, but in general, we are looking for credits in companies that have stable to improving fundamentals. If they're deteriorating, we don't buy them, on the theory that it's already in the price.
We want to see some stability. We look at it from an equity standpoint. We don't care what currency they're denominated in or the fact that they may be in an industry that's in favor or out of favor.
So we end up with companies like TRW, an auto parts supplier (TRW ). We no longer have it, because it was tendered out of the portfolio, but it gives you a sense of how we approach things.
Many years prior to its current ownership, TRW had bought another auto parts company called Lucas Varity, which is primarily Europe-based. The TRW bonds are all in the index, and our favorite competitors are chasing after those bonds day in and day out. They're pretty fully priced. But Lucas Varity bonds were interesting to us for a number of reasons that made them ugly to everybody else.
First of all, they were denominated in pounds sterling. That's a nonstarter for most funds to begin with. We, on the other hand, want to find good credit and a bond at the right price. If we have currency risk at the end, we then decide what we want to do with it. So that was not an impediment.
Second, the bond was a 30-year, and many high-yield players don't like to go much beyond 10 years. I find this a little bit absurd, because these companies usually either go bankrupt or get bought or morph themselves into something else within three or four years. So whether I buy a 10-year or a 100-year, there's not a lot of difference.
The third reason most high-yield managers didn't like the bond is because it was non-callable. Most high-yield bonds are callable. In my mind that was a sign of why I should like it, because I wasn't giving the company all these options to call the bond away from me if the situation improved.
As Lucas Varity and TRW continued to improve, I reaped all that benefit. The company tendered the bonds away from us at a very healthy premium to what we bought them at. That's an example of the kind of thing I believe we can do by taking a much broader look at what's out there.
What factors are influencing your outlook? My outlook is definitely more positive than most. People love to hate high-yield. Right now people are particularly nervous about it because spreads are relatively tight to recent history.
I don't think anything is going to cause those spreads to widen out enough to hurt you in the long run, especially if you take at least a 12-month time horizon.
The trick with high-yield is to be invested, because you don't want to forgo that coupon -- especially if you think you're in an environment that is relatively stable, which I believe we are.
While you're invested, you obviously have to keep your eye on the possibility of that 1- and 10-year explosion that seems to come along for high-yield, whether it's an Asian currency crisis, or a Drexel Burnham going bankrupt, or just an outright recession. Right now I don't see anything on the immediate horizon that would make me back off, but you've got to be worried.
Is there anything else that investors should keep in mind about global high-yield? Investors need to look at this asset class as broadly as possible and invest carefully. By carefully, I mean take more of an approach that an equity investor would take, which means don't just crunch ratios on these companies. Understand what the business of these companies is and how they're positioned.
Another thing I think many equity investors will do is recognize that you can be wrong, and always be quick to sell if something happens that contradicts your original thesis. It's important to define your market properly when you start out, and then bring an investing discipline.