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A Better Balanced Fund - The 7Twelve multi-asset balanced portfolio

The 7Twelve is a multi-asset balanced portfolio that meets the requirements of a qualified default investment alternative (QDIA) under the provisions of the Pension Protection Act of 2006.

Unlike a traditional two-asset 60/40 balanced fund, the 7Twelve balanced portfolio utilizes multiple asset classes to enhance performance and reduce risk.

The 7 of 7Twelve represents the suggested number of asset classes to include in your portfolio. The Twelve represents the 12 separate mutual funds or exchange traded products to fully represent the 7 asset classes in your 7Twelve portfolio. Our portfolio has approximately a 65/35 allocation: approximately 65% of the portfolio is invested in equity and diversifying assets and about 35% invested in bonds and cash.

Some of the asset classes, such as US stock (also referred to as "equity") require several mutual funds to adequately represent their diversity. The US equity asset in the 7Twelve portfolio requires three separate funds: one fund that invests in large US equity, one fund that invests in mid-sized US companies, and one fund that focuses on small US stocks.

The non-US equity asset requires two separate funds, one focusing on large non-US stocks and one that invests in stocks of developing or emerging non-US countries. Real estate, as an asset class, is adequately covered by one mutual fund that invests globally in real estate and real estate linked companies.

The asset class of "Resources" requires two separate funds (or sub-assets): one that invests in natural resources companies and another fund that invests in actual commodities (cattle, precious and industrial metals, wheat, corn, cotton, etc.).

Investing in US bonds requires two different funds, an aggregate bond fund and a fund that specializes in inflation-protected bonds. Adding International bonds requires a separate fund. Finally, cash is added to the portfolio by including a money market fund.

Building a Better Balanced Fund

A Better Balanced Fund The 7Twelve multi asset balanced portfolio

For more details, please download Building A Better Balanced Fund (January 2010).

A Better Balanced Fund The 7Twelve multi asset balanced portfolio

Thus, the 7Twelve portfolio includes 7 core asset classes and utilizes 12 specific mutual funds. Each mutual fund (or "sub-asset") is equally weighted, meaning that each fund represents 1/12th of the portfolio. This allocation is maintained by rebalancing the portfolio back to equal portions annually, quarterly or monthly. (The performance reported on this web site assumes monthly rebalancing, whereas performance based on annual rebalancing may also be illustrated in some of our white papers.)

The tax efficiency of the portfolio (during the accumulation period prior to retirement) can be enhanced significantly by using new cash inflows to accomplish the systematic rebalancing. Rebalancing consists of adding money to the funds that have a balance less than 1/12 of the total portfolio. (Rebalancing does not affect the tax efficiency of the 12 individual funds within the 7Twelve portfolio.)

Systematic rebalancing does NOT represent tactical portfolio management. In fact, it is just the opposite. Rebalancing is a portfolio management technique designed to protect the portfolio from emotionally charged buy-and-sell decisions – most of which usually cause more harm than good. Most portfolio "tacticians" (people who try to outsmart the markets they invest in) subtract more value than they add. Rebalancing takes emotion and second-guessing entirely out of portfolio management.

Of course, you can choose an asset allocation model and rebalancing protocol to suit your own needs. For example, a very conservative investor may choose to weight fixed income and cash higher. It has been found that a rebalanced, multi-asset, equally weighted portfolio achieves the two major objectives of a portfolio:

1. Grow money.

2. Protect money by avoiding losses.


doc/20100327212227_A_Better_Balanced_Fund.pdf



A Better Balanced Fund

By Scott Burns

Craig Israelsen has an interesting idea: Let’s leave 1950 behind.

The associate professor at Brigham Young University in Utah thinks it is time to include the world outside the United States, among other things, in our investments rather than just talk about it.

In a brief paper last year he urged junking the traditional balanced portfolio— 60 percent domestic equities and 40 percent domestic bonds— for a new model. A broader selection of assets, he said, would provide a higher return with less risk.

This is accomplished with what Israelsen dubs the “7Twelve Balanced Fund.” Rather than having just domestic stocks and bonds, the new benchmark has seven asset classes. Those asset classes, in turn, are sub-divided into a dozen sub-sets, all held in equal amounts.

And the payoff is huge.

Over the last 10 years, his better balanced index provided a return of 7.52 percent annualized. Even as it did better than nearly 60 percent of its managed competitors, the Vanguard Balanced Index fund returned only 2.64 percent over the same period.

That 7.52 percent return would have ranked Israelsen’s passive index in the top 2 percent of all moderate allocation funds. Indeed, it would have ranked in the top 30 percent of all world allocation funds— funds that do invest in a broader menu of assets (the table below shows the figures).

Of course, this wasn’t just any 10 year period. Just as there have been periods where foreign stocks and bonds, commodities and real estate provided higher returns than domestic stocks and bonds, we may have future periods where domestic assets provide higher returns than foreign assets, real estate and resources. This is no guarantee of investment nirvana— but it’s a good start for a new millennium.

One reason it has taken so long to modernize the traditional balanced fund is simple. What seems obvious today would have been difficult to do only a few years ago. As recently as 10 years ago many of the index investing vehicles we now take for granted did not exist. Today there are over 900 exchanged-traded index funds. These funds allow you to invest in virtually any slice of a market you can imagine, including the kinds of assets that Israelsen used to build his broader balanced portfolio.

Ten years ago there were only 32 exchange-traded funds. Twenty years ago there were only 12 index funds of any kind. Things change.

Some readers are probably thinking, “Gee, this seems familiar.” It is. The original two-part Couch Potato portfolio was introduced in September 1991. With it you could become your own money manager and beat about 70 percent of professional managers simply by dividing your money in two equal parts and committing to two low-cost index funds, one for stocks, and one for bonds. (And, yes, you are allowed to use a hand-held pocket calculator to divide by 2.)

To honor the Buffett named Jimmy, I added foreign equities and created the Margarita portfolio in 2004. Managing this portfolio is still easy, thanks to the abundant practice many of us have making the most popular drink in the Southwest.

Making portfolios with up to six Couch Potato Building Blocks was introduced in 2005 and further expanded to ten blocks in 2007.

The common denominator here is simplicity. Whatever the number of blocks, you always invest equal amounts in low-cost index funds. That would be up to 10 blocks with the Couch Potato portfolios, or an even dozen with the 7Twelve balanced fund.

Doing this on your own 10 or 15 years ago would have required some fancy footwork. You would have had to substitute some managed funds in some categories. Today, it’s pretty much a slam dunk to build any of these portfolios—and you’ll keep your annual investing expenses under about 40 basis points, or 0.40 percent.

The return you save— and the money you grow— will be your own. You can check the trailing returns of all 9 Couch Potato Building Block portfolios, updated monthly on my website. You can read more about the 7Twelve portfolio on its website, www.7twelveportfolio.com.

Old World vs. New World Balanced Funds

This table compares the annualized returns of a 12 component balanced fund with the traditional 60/40 domestic balanced fund. The returns of the Vanguard Balanced Index fund reflect annualized expenses of 0.25 percent while the 7Twelve Balanced Index is based on index returns with no costs.

Measure 7Twelve Balanced Index Vanguard Balanced Index
2009 25.24 percent 20.06
3-year-annualized return 1.02 (0.28)
5-year-annualized return 5.93 2.87
10 year-annualized return 7.52 2.64
Number of negative years 3 4

Ref : http://assetbuilder.com/blogs/scott_burns/archive/2010/03/26/a-better-balanced-fund.aspx




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Categories : Finance    Themes : Investing Buy and Hold
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