Managers’ Special Report: Buys & Sells – Core Equity Funds

Based on data from March 1, 2010

Core equity funds (Class 3 for newsletter subscribers)

Over the last few months, we have reduced exposure to diversified developed market foreign funds (mainly European) in favor of domestic mid- to large-cap funds. Our rankings now favor domestic mid-caps, especially mid-cap value, and the current core “buys” are now only 7% foreign. Including “holds”, our core holdings are now less than 25% foreign.  ETF-only portfolios have only 5% in foreign core ETFs.

Of recent interest is the wide disparity among foreign fund rankings. Funds concentrated in Europe are among the lowest ranking, but more diversified foreign funds (especially those with exposure to Australia and Canada) remain highly ranked. Much of this divergence may be currency based, but regardless of why, we are glad our rankings have steered our portfolios away from the laggards. All foreign funds have lagged domestic funds this year-to-date.

Among domestic funds, smaller companies are leading and mid-cap funds and ETFs are clearly the strongest category of core equity funds.

Summary:  We continue holding or reducing foreign developed market fund exposure in favor of domestic mid-cap funds, emphasizing mid-cap value. ETF-only portfolios hold less foreign exposure because most foreign Core ETFs are “sells”.

Managers’ Special Report: Buys & Sells – Speculative Equity Funds

Based on data from March 1, 2010

Speculative equity funds (Classes 1 and 2 for newsletter subscribers)

Despite a volatile start to 2010, emerging markets remain highly ranked and speculative holdings are skewed to emerging markets. We favor diversified emerging market funds and BRIC [Brazil, Russia, India, China] funds over individual country funds.

Our mutual fund portfolios have experienced little turnover in recent months as many funds remain “holds” despite relatively weaker recent performance. Our ETF-only portfolios adhere to a tighter sell threshold leading to significant changes to portfolio weightings. The ETF-only portfolios have sold agriculture and Taiwan, and reduced emerging markets exposure.

Last month, we noted that domestic small-cap funds had risen in our ranks. Domestic small-cap funds continue to lead, earning a greater weight among our speculative holdings (especially in ETF-only portfolios). Mid-cap growth is also highly ranked, and we maintain modest exposure to banks, retail, semi-conductors and materials. The newest sector to reach “buy” status is REITs, and we have included a REIT ETF among our most speculative positions.

Summary:  We continue to hold diversified emerging market funds and ETFs. We also have modest holdings in leading domestic speculative funds, including mid-cap growth, small-cap (especially small-cap value), banks, retail, materials, semi-conductors and REITs.

Managers’ Special Report: Buys & Sells – Flexible Income Funds

Based on data from March 1, 2010

Riskier bond funds enjoyed spectacular gains in 2009, rebounding sharply from dramatic losses in 2008. These include high-yield bond funds, emerging market bond funds, foreign bond funds, and some of our favorite Class 4 alternative funds. We recognize that the rate of increase in these funds is unsustainable and have watched especially closely as each of these categories soared to new highs. Gains have been more challenging so far in 2010, as interest rates and currencies have been more volatile and credit risks have been priced more aggressively.

We are thrilled to include exposure to riskier bond funds in our flexible income strategy but we also recognize that risk management is the top priority for the fixed income component of investment portfolios. In that context, we are more sensitive to trend changes among riskier bond funds and may deliberately sell these positions in favor of the highest ranking more conservative bond funds when we see evidence of a weakening trend. Based on a recent break in trend strength, we are currently compelled to reduce exposure to high-yield bond funds and sell emerging market bonds, adding to less volatile, high quality intermediate-term bond funds.

Summary:  Our flexible income portfolios continue to benefit from diverse exposure to a variety of bond funds and alternatives. We are happy our portfolios outpaced the benchmark aggregate bond index, and we have locked in some gains on riskier holdings leading to a moderately more conservative posture. We remain overweight short duration bond funds and have reduced high-yield and emerging market bond holdings in favor of high-quality intermediate-term exposure.

Managers’ Special Report: Tactical Model Perspective

Based on data from March 1, 2010

Current Tactical Model perspective

Composite:      Bearish
Trend:              Neutral (weakening)
Valuation:        Bearish
Sentiment:       Neutral

Equities bounced back in February following January’s declines although most remain slightly negative year-to-date. Our tactical portfolios held up well in the January’s pullback but did not participate in February’s rally as we remain defensive based on continued deterioration in our models. The net effect of this is favorable year-to-date versus our fully invested portfolios.

Last month we discussed how the correction that began in January had helped reduce excessive optimism and, when combined with good earnings, valuations were moving closer to their long-term average. We expressed our hope that the correction would ultimately set the stage for a continuation of the bull market as sentiment became more supportive, the market less over-bought, and valuations pulled back within a more normal range. The February rebound reversed those improvements (prematurely by our measures), leaving the market vulnerable to further correction once this bounce fades.

Perhaps the 2010 correction is over, and the bull market that began in March 2009 is set to resume. Only time will tell. Based on the current weight-of-the-evidence, our tactical portfolios remain defensive, holding considerable cash and well hedged through a combination of covered calls and protective puts. We may diversify our hedge to include inverse ETFs in lieu of protective put options.

As always, our long portfolio is based on Upgrading. We therefore emphasize domestic mid-cap funds and ETFs, especially mid-cap Value. We have modest exposure to core foreign funds and some speculative exposure to diversified emerging markets ETFs.

At this time, we are looking for a trigger to increase long exposure and/or reduce our defenses.  That trigger could be a thrust higher, but we expect that a continued correction would be required for our models to turn more bullish.

Summary:  We remain cautious. Our Tactical portfolios held up well in January’s pullback due to considerable defensive posturing – and did not participate in February’s bounce for the same reason. The net effect of this is favorable year-to-date versus fully invested portfolios.

Renewed trend strength could trigger a buy, but the weight of the evidence leans towards a continuation of the correction before the bull market resumes. For now, our tactically portfolios are defensive.