Happy New Year and thank you for your support! 2007 turned out to be a good year for Kinetic Financial. Our Large Model Portfolio returned 11.3% compared to 5.5% for the S&P! On average, the Small, Medium, and Large model portfolios returned 10.9% in 2007.
Our performance will generally be some weighted average of the S&P, MCSI EAFE (International index), and MSCI EM (Emerging Markets index), depending on which of these indexes perform the best from a Risk and Reward perspective. During a shift in market leadership, such as the one we experienced starting in February 2007 (market leadership shifted from Small Cap Value to Large Cap Growth), we will tend to under perform the broad market indexes as we redeploy our investments. However, if market leadership remains stable for sometime (6 months or more), we will tend to catch up and surpass the broad indexes by recommending and investing in funds with high alpha compared to the broad indexes.
So, was all the Kinetic Financial buying and selling activity in the Model Portfolios worthwhile? You could look at any individual fund that we recommend (MMUCX, ADINX, THOIX) and say "hey, I would have done better if I invested all my money in any one of these funds!" Or, you could say "hey, I could have done just as well if I invested all my money in EFA which tracks the international index."
Our belief is... absolutely yes! It was absolutely worthwhile to have the buying and selling activity in the Kinetic Financial Model Portfolios. Why? Here are a few reasons:
1) Hindsight is always 20/20. The question is not "Where should I've put my money 12 months ago to get the best return?" Rather, the correct question to ask is "Given all the information I have today and the state of the market as it exists today, where do I have the highest possibility of making a good return with low risk over the *next* 12 months?" This is why our tag line is "mutual fund recommendations for the prevailing market conditions." We try to determine the state of the world today without making any predictions for the future. When tomorrow comes, we re-evaluate our recommendations to see if the state of the world has changed. Our goal is to spread investments over many high performance funds that appear to have good Risk/Reward profiles. If a fund changes behavior (does not conform to its recent risk and reward characteristics), we sell it. If a fund continues to exhibit the same behavior over time, we continue to accumulate positions in the fund.
2) We reduce market exposure during down markets by selling our weakest positions which protects us from an extended bear market. During the February & July 2007 downturns, we were almost 30% in cash. History has shown us that during person's lifetime, very large market corrections *will* occur. The NASDAQ lost 78% during the 2000 technology bubble burst; during the Great Depression the stock market fell 86% over a 34-month period; and finally, after the 1973-74 market plunge, the market did not recover for more than 7 years. By definition, indexes are always 100% invested in the market. Most mutual funds must remain close to 100% invested in the market to compete with their benchmark indexes during short time frames. Therefore, it is up to us to control our market exposure in the event of an extended bear market. Selling weak positions and adjusting market exposure gives you complete control of your downside risk. For me, knowing that I won't lose my shirt no matter what the market does helps me sleep at night.
3) No single fund can have high performance forever. Good funds tend to have a lifecycle. If a fund has good performance, eventually people catch on and assets are attracted to the fund. Then, the fund experiences asset bloat and the strategies that made the fund successful in the first place often don't work anymore-- the fund begins to behave like the index. Smart fund managers that are not greedy tend to close their funds to new investors to keep assets at manageable levels. So, the trick is to identify high performing funds early enough in their lifecycle before they close their doors to new investors. When we recommend buying a fund, we know that someday we will need to recommend selling that fund because the money will be better elsewhere. We don't know if the behavior of the fund will change in 1 month; 3 months; 12 months; or 5 years. However, we keep this uncertainty in mind and try to invest in funds with low transaction costs and high liquidity.
4) Our portfolio allocation automatically shifts to keep it in line with market leadership. At the beginning of 2007, our portfolios were heavily invested in Small Cap Value funds which have had great run during the past several years. Now, we are mostly invested in Large Cap Growth funds. Small Caps lagged recovery after the February, July, and November 2007 downturns. As a result, we redeployed our cash into the fast growing areas of the market which was demonstrated by Large Cap Growth and International funds.
5) Our model portfolios are scalable to help you manage 100% of your wealth. Yes, you could have made 50% in 2007 if you invested in Google, but would you have invested 100% of your net worth in Google? Even if you use Kinetic Financial to manage millions of dollars, your ownership stake in any single stock will most likely be a fraction of a percent based on the mutual fund stock holdings. This allows for incredible diversification. Also, we provide additional downside protection because we reduce market exposure during down markets.
6) We boil the ocean of funds out there down to a cup of tea. You may think "hey, this fund that I've invested in looks pretty good but Kinetic Financial does not recommended it." Yes, but we are screening almost every fund that exists in the marketplace-- over 17,000 unique fund symbols. If it's on Morningstar, we've screened it. If your fund didn't pass our screening algorithm, it's probably because of its Risk profile relative to its performance weighted more heavily on the most recent market downturns. We will always gravitate toward high performing funds that have demonstrated less risk in the most recent market downturns.
7) If you take $100,000 today with a compounded rate of return of 10%, you'll have $1.7M after 30 years. If you take that same $100,000 today and achieve a rate of return of 15%, you'll have $6.6M after 30 years. It's worth fighting for those few extra percentage points of return every year! That's the power of compounded returns. If you look at our performance track record, you'll see that we generally beat the broad market by 5% to 10% year-over-year. That's with downside protection! Past performance does not guarantee of future returns. However, this year we were able to achieve our personal target performance objective of 5% to 10% over the broad indexes.
Thank you everyone for your support. May 2008 bring you happiness, joy, and sunshine. Please add a comment if you have any questions. Even if you don't have a question, your positive (or negative) feedback would be appreciated.Labels: model portfolio performance, Mutual Fund Recommendations, Track Record
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