Reuters Money

Zap zombie funds within your portfolio

Do you have zombie index funds within your portfolio?

Instead of eating up your brains, they devour your nest egg with high expenses and walking dead performance. They may be lurking within your 401(k)-type plan or individual retirement account.

I like index funds because they generally can track nearly any kind of asset class. As such, they are the white bread of investing and should cost about the same from fund to fund. The cheaper the better. Why pay Nieman-Marcus prices for the same thing you can get at Costco or Sam’s Club for less?

You can vanquish these funds without overtly violent acts, but first you have to identify them. Unfortunately, mandated fee disclosure is still pending, so you have to take the initiative.

So how do you identify a zombie fund? First you need a reliable benchmark for comparison purposes. The easiest way is to look at the index that the fund is supposed to be tracking. A good proxy for the U.S. bond market, for example, is the Barclays Capital Aggregate Bond Index. It’s a basket of listed bonds. If a fund tracks the index return within 0.20 percentage points or less, then that’s pretty good and not expensive.

A low-cost bond index fund would look like the Fidelity Spartan Intermediate Term Bond Index investor class fund, with a 0.20 percent expense ratio. You’d need at least $10,000 to get into this fund, though.

You want to pay a manager more to get less return on bonds? The ING US Bond Index portfolio charges a hefty 0.95 percent annually, meaning it will lag the index by nearly a full percentage point every year.

5 ways to make a bond ladder work for you

The mention of bond laddering often makes one think of retirees sitting on the sidelines of the market, buying individual bonds with staggered maturities to goose up their yields, but lately it’s not such a doddering strategy.

With bond yields low, savings account interest rates microscopic and stock volatility scary, younger investors and even college savers are starting to embrace the time-honored laddering strategy. If can work for people who don’t want to lock up all of their money in long-term investments but want more yield than they can typically get in short-term savings vehicles.

Bond laddering also adds an element of predictability to a portfolio, since each bond produces a set amount of income and returns principal at a specific date.

Stan Richelson, a financial advisor in Blue Bell, Pennsylvania, recently constructed a ladder for a couple whose child was starting college in six years. The first of the four investment-grade municipal bonds, which matures freshman year, has a tax-free yield of 1.5 percent. The last, which matures in 2020, yields 2.35 percent. That translates into taxable equivalent yields of 2.24 percent and 3.5 percent, respectively, for investors in the 33 percent federal tax bracket.

“That may not sound like all that much,” he says. “But you’re still getting a decent return and you know the money will be there when you need it.”

Bond ladders have some limitations, though.

But buying individual corporate and municipal bonds usually requires a total investment of at least $50,000 to $100,000 to get adequate diversification and avoid high markups on small transactions, says Kathy Jones, a fixed income strategist with Charles Schwab. Smaller investors can get around that by  laddering Treasury securities or certificates of deposit, since investment minimums are so low.

Searching for yield? Think savings bonds

Yields on certificates of deposit, Treasury bonds, and other interest-bearing securities have gotten so low that a mundane investment usually associated with birthdays and bar mitzvahs looks enticing by comparison.

But if you’re thinking of buying Series I savings bonds you might want to do it soon, since new regulations set to take effect next year will limit purchase amounts and make them harder for many people to buy.

Thanks to an uptick in prices for gas, food and other consumer goods, the bonds — which peg their yields to inflation — carry an annualized yield of 4.6 percent. By comparison, the average rate on a one-year CD is around .75 percent.

The variable rate, which applies to I-Bonds issued from May through October, consists of two blended components: a fixed rate that stays the same over the entire 30-year life of the bond and a rate pegged to the Consumer Price Index for All Urban Consumers (CPI-U), which changes twice a year.

The rate will re-set on Nov. 1 and based on recent inflation numbers would come in at around 3.3 percent according to Tom Adams, author of the book Savings Bond Advisor. While that’s lower than the current rate, which lasts for six months on bonds purchased through October, it’s still better than most other alternatives out there.

“People should look at I-Bonds as inflation insurance,” he says. “And right now their yields are quite attractive, especially compared to other types of interest-bearing investments.”

One drawback is you have to hold the bonds for at least a year, and you’ll forfeit three months of interest if you cash them in before five years. But even after the interest penalty, I-Bonds are still a better deal than a low-yielding CD.

4 ways to hedge the market without playing whack-a-mole

Is the recent market upheaval the growling of a new, prolonged bear market or a tempest in a teapot?

It’s too soon to tell and most of us will guess wrong anyway. As Washington and global traders sort out the impact of the U.S. “Tea Party debt downgrade,” you should employ the best hedging strategies possible.

Of course, if you already have a comprehensive financial plan with an investment policy statement in place — and it’s working for you — you’re probably fine. While the ongoing market angst is troubling, you’re still on course.

The only thing that’s guaranteed is that Euro Zone debt woes, the threat of a double-dip recession and ongoing U.S. budget battles will create more short-term volatility than a tropical storm.

Here are some ways of avoiding the market turmoil:

Build a can’t-stomach-stocks portfolio There’s no shame in protecting your principal, particularly if you’re in or near retirement. The last decade was bad enough, and you shouldn’t have to suffer any more losses. If you can’t afford to lose anything, you shouldn’t be in stocks anyway. One way of dynamically measuring risks and avoiding market downturns is through tactical asset allocation.

The site MyPlanIQ provides some ways of customizing your portfolio to the kind of risk you can stomach. One simple, ultra-safe model they suggest combines just two income funds: The PIMCO Total Return fund and the Vanguard Short-Term Bond fund . About 67 percent of the plan is allocated to the PIMCO fund and 33 percent to Vanguard. While this portfolio doesn’t completely offset interest-rate risk, it’s a good place to be if stocks are tanking and there’s negligible inflation.

Fund managers see tough times for Treasuries

The fact that U.S. Treasury bonds managed to cling to their coveted triple-A rating this week failed to impress several prominent bond fund managers, who say they are lightening up on Treasuries and stocking their portfolios with corporate bonds instead.

Despite the debt ceiling deal, U.S. sovereign debt remains in the crosshairs of ratings agencies like Moody’s and Standard & Poor’s. The rating agencies remain concerned that the U.S. is “not doing enough to reduce spending and/or increase revenues to bring down the trajectory of the country’s mounting debt,” warns BlackRock’s head of fixed income portfolio management, Peter Fisher, in a report issued earlier this week. If the U.S. were to be downgraded by one or more agencies, he observes, “the odds are very high that there would be knock-on consequences of other borrowers getting downgraded — both corporate and public, in the U.S. and overseas.”

Robert Persons, who manages the MFS Bond Fund, believes corporate America is replacing Uncle Sam as the borrower with the strongest financial profile. He exited U.S. Treasury debt nearly two years ago and has not returned since; he asserts government bond yields are so low that the risk of investing in them just isn’t worth it.

“Companies are the ones who have fixed their balance sheets, cut costs, and generated higher cash flows,” he says. “It’s the public sector that’s dropped the ball and left taxpayers to pick up the tab.”

Even before all the debt drama unfolded, many bond fund managers weren’t enamored with U.S. Treasury bonds because of their historically low yields, which are currently hovering at about 2.6 percent for the 10-year bond.

The average intermediate-term investment grade bond fund has about 14 percent of its assets in Treasury securities, according to Lipper — less than half the 32 percent weighting in that sector for the Barclays Capital U.S. Aggregate Index, a benchmark for U.S. investment-grade debt.

A number of fund managers with the flexibility to pick their spots in the bond market had little or no exposure to Treasury securities before the debt debacle, and have no plans to up the ante any time soon.

6 ways to protect your portfolio after debt deal

With the U.S. debt ceiling crisis: It “ain’t over ‘til it’s over,” to quote my favorite philosopher Yogi Berra. And this one is definitely not over by a long shot.

Some $1.5 trillion in cuts in federal programs will be considered toward the end of the year. Credit agencies may still downgrade U.S. debt. And the harsh plan may ultimately damage the floundering American economy. Fortunately, you have time to protect your portfolio before another politico-economic reign of terror ensues.

Start with an assumption that the markets may frown on U.S. debt and the dollar in general. And there may not be much – if any – significant economic growth in the U.S. for some time. Here are six key portfolio themes that you can consider to bolster your portfolio and insulate it from global debt woes.

A bear market in U.S. bonds. The bull market that got its start in the 1980s may be at the end of its run. Will inflation or investor insecurity trigger a flight from what was seen as the safest debt in the world? If you’re really nervous about U.S. Treasuries, trim your holdings in the longest-maturity notes. To hedge against interest-rate risk depressing government bond prices, consider the Direxion Daily 20+ Year Treasury 1x Shares exchange-traded shares. If the index linked to these bonds goes down, the value of this ETF goes up.

A bear market in the euro and dollar. There’s no easy resolution to Eurozone and U.S. debt dilemmas. Are there “safer” currencies relative to the buck and Euro? You can either buy stocks or AAA-rated bonds in some of the better fiscally managed countries such as Australia, Canada and Switzerland, or currencies from those countries. A more precise way of hedging currency risk is to find a country like Switzerland that’s seen as relatively secure and invest in an ETF such as the CurrencyShares Swiss Franc Trust.

Dividends rule. Not subject to partisan wrangling or sovereign debt debacles, corporate dividends are based on real earnings. Most consistent dividend producers are multinational companies that derive their profit from global enterprises. To find a pool of regular dividend payers, invest in an ETF like the SPDR S&P Dividend ETF. The fund tracks a group of dividend “aristocrats” selected for their consistent payouts over time.

Emerging markets bonds. Though not in the same league as U.S. Treasuries – that may change – bonds issued by developing countries are worth eyeing for diversification and higher yield. The WisdomTree Emerging Markets Local Debt ETF tracks an index of such issuers.

Investing: A little inflation isn’t such a bad thing

We’re in a three-headed hydra economy now. There’s the threat of burgeoning inflation, joblessness and a rotten housing market.

Yet the idea that rampant inflation will trigger an investment debacle is perhaps overblown. A touch of inflation can be a good thing and it depends on how you invest.

I’m not discounting the possibility of a bond bubble bursting, so be sure to shorten your maturities on high-quality bonds because they will get hardest hit by any interest-rate increases. Beyond that, the news may not be all that bad based on historical results for stocks.

Consumer inflation is running at a nearly four percent clip, according to the latest government report, which shows the annual rate at its highest since June, 2008. The bulk of the increase was in energy (fuel prices — up 21 percent) and food.

A little inflation isn’t that toxic to stock returns. According to research from the Leuthold Group, stocks often gain in periods of mild inflation. The last time inflation was climbing at least three percent, stocks did just fine. Leuthold found that in September, 2000; September, 1996; and June, 1995, the subsequent one-year performance of stocks was 13 percent, 20 percent and 26 percent, respectively.

Although there are exceptions to these trends — December, 2002 had a one-year trailing decline of 22 percent (recession-induced) — the overall conclusion is that “in those periods of mild inflation 45 of 53 periods (going back to 1926) had positive [stock] returns.”

What happens if inflation creeps substantially over the three percent threshold? Only four of those periods in the Leuthold study showed gains. One thing is fairly certain: Stocks generally don’t do well during high-inflation times. In the 1970s, when inflation averaged 7.4 percent — it was double that toward the end of the decade — stocks only rose about five percent, according to Ibbotson Associates. That compares to an 18 percent average stock performance for the 1990s, a decade in which inflation averaged less than three percent.

Scary and scarier: rising prices and rising rates

Data expected out of Washington this week may raise anxiety levels of investors and consumers who are already worried about inflation and rising interest rates.

On April 12, the Bureau of Labor Statistics reported that U.S. import prices jumped in March. We’ll also get data on producer prices on April 14 and consumer prices on April 15. But here’s what we already know: It costs more to fill your car, and your belly. And what doesn’t run on food or fuel?

At the same time, Federal Reserve officials have gone out of their way to pooh-pooh the dangers of inflation. That just worries consumers and bond investors all the more. If niche commodity price increases start feeding through to other goods and services, or if the Fed starts throwing around too much cash, the end result could be rising long-term interest rates. And rising rates could slam bond investors, who would lose money if the prices of their bonds fell to create higher yields. That would be particularly bad for mom and pop retirement investors who have been told that bonds are “safer” than stocks.

So, what to do, what to do? Realize, first, that rising prices and rising long-term bond yields are two distinct and different situations. “Even though in theory, they should be linked together, the math shows they don’t move in lockstep,” says Tim Courtney of Burns Advisory Group in Oklahoma City. Long-term bond yields are more likely to rise ahead of consumer inflation. They’ll rise when bond fund investors start to expect future inflation.

That means investors and consumers should be planning for both eventualities separately. Here are five ways to protect yourself from rising rates. (We’ll address rising prices in a later post.)

Be careful about TIPs. Treasury inflation-protected securities promise to protect portfolios from the ravages of inflation, through a complex pricing mechanism. Their yield is divided into two parts: a fixed yield and a yield guaranteed to rise with the Consumer Price Index. Right now, they are more expensive than regular Treasuries — an expectation of two percent annual inflation is built into their price, says Courtney. That means they will only pay off if inflation runs higher than that, but that isn’t the real risk with these bonds. The real risk is that interest rates will rise, but prices won’t. Then what happens to TIPs holders? They’ll get slammed. Their yields won’t rise and their prices could fall.

Short bonds. This is something Pimco’s bond buff, Bill Gross, has already started to do. His Total Return Fund — the world largest bond fund — began shorting Treasury debt in March. Ed Easterling, president of Crestmont Research, an investment research firm, suggests that this is one of the very few ways you could buy “proactive protection” from future inflation. If rates go up in anticipation of future inflation, and you’re shorting long bonds (in effect, borrowing bonds and selling them at today’s prices), you’ll gain when bond prices fall and you can cover your short position with cheaper bonds. That sounds complex, but you could do that by buying shares of an exchange-traded fund, such as the Proshares Ultra Short 20 Yr Treasury, that inverts and doubles the performance of long term Treasury bonds. Even more aggressive, reports Lipper, is the Direxion Daily 20+ Year Treasury Bear 3x exchange-traded fund. That inverts the Treasury 20-year bond and then triples it.

PIMCO: The stockpicking powerhouse?

PIMCO gets plenty of attention for its bond funds. The fund company is best known for PIMCO Total Return, America’s largest mutual fund, with a staggering $237 billion in assets. When manager Bill Gross talks, markets move.

For the past few years, however, PIMCO, which is based in Newport Beach, California, is gaining notoriety for its stockpicking prowess. At the Lipper Fund Awards on March 23 in New York, PIMCO took the best equity award among large mutual fund families. (Loomis Sayles won in the large fixed-income category.) And that’s no easy feat for a firm that is going head to head with equity powerhouses like Fidelity Investments and T. Rowe Price, says Tom Roseen, senior analyst at Lipper.

Overall, PIMCO manages more than $460 billion — $383 billion in billion in fixed-income assets and more than $77 billion in equities, according to Lipper, a unit of Thomson Reuters. Here are the six funds that earned PIMCO the Lipper Fund Award for large equity management.

To be fair, these funds aren’t standard, plain-vanilla long equity portfolios. “These are not everyday, run-of-the-mill funds,” Roseen says.  PIMCO does have other equity funds, but they were not eligible for a Lipper award for various reasons.

The funds that did make the cut capitalize on what PIMCO is known best for – sophisticated fixed-income investing. “It’s their bond expertise that makes these ‘stocksPLUS’ or ‘real return’ strategies compelling,” says Azim Nakhooda, chief investment officer and principal at Cedar Brook Financial Partners in Cleveland, Ohio, who uses both kinds of funds in client portfolios.

For example, in the StocksPlus fund, PIMCO uses equity index futures to potentially outperform a stock index — and the StocksPlus Total Return goes one step further, mixing in short-term bonds. “It’s pretty innovative,” Nakhooda says.

T. Rowe Price: The target-date fund powerhouse

Driving a team of a dozen horses toward the same destination, when they are tied to one another by a strong harness and responsive to commands, may appear to be easy, but it may not be.

Driving a team of a dozen mutual funds toward different distant years, connected by a common investment strategy within the parameters of a finely spun web of government regulations of securities and retirement plans, doesn’t appear to be easy, and it probably isn’t.

Yet, despite the recent recession and bear market, Jerome A. Clark, portfolio manager of the twelve T. Rowe Price Retirement Funds since the group’s organization in 2002, had five of them repeat as winners of Lipper Fund Awards for consistently superior risk-adjusted returns in their Lipper investment objective categories for periods ended December 31.

T. Rowe Price Retirement 2040 Fund repeated as winner for outperforming peers in its mixed-asset target year category for both the last three and five years. The 2030 fund repeated as winner for the last five years and won for the last three — as it did 2015 and 2025 — and the 2005, 2035 and 2045 funds also repeated for the last three.

The awards are given for consistently superior performance based on Lipper’s proprietary methodology for computing risk-adjusted returns.

What Lipper calls mixed-asset target funds — and others call target-date or lifecycle funds — are the 87-year-old mutual fund industry’s newest major fund type. Investment policies and strategies may differ, but they have things in common — each fund’s assets are invested primarily in stock and bond funds — usually sibling funds. The funds move along a glidepath, becoming more conservative as investors near retirement.

For younger investors, a fund starts with 90 percent in stock funds. By retirement, equity holdings will drop to 55 percent.