Finance and Credit Professional

Want to structure your mutual fund portfolio to achieve optimal returns for the next twenty years? Read on or just skip to the last paragraph.

There was a great article in the June CFA Institute publication Expected Rates of Return: Back to the Future by Jim O'Shaughnessy. Mr. O conducts solid research, writes clearly, and makes recommendations. This unusual combination of talents first came to my attention when I read What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time. Although the book discusses stocks, Mr. O's research and conclusions are applicable to mutual funds. The article published in by the CFA Institute is a synopsis of his work.

Mr. O reminds us that most money managers lack the discipline to consistently execute strategies. That's true for us investors - we tend to change our strategies, following the hot idea in the market - as it is for professional money mangers. Note to self: make sure your fund manger follows their stated investment strategy. The corollary to disciplined investing is not to expect to outperform the market every quarter. Even Warren Buffett doesn't. Adhering to these principles alone will make us better investors. Chasing quarterly results and/or changing investment strategies only guarantees one result in a bad performance.

Mr. O uses rolling 20 year periods (i.e., 1945 to 1965, 1946 to 1966), and went back fifty years to measure performance and draw his conclusions. He first published his work in 1996. Ten years later (as discussed in the article and the newest edition of his book) he looked at the performance of the strategies recommended in 1996. They worked! Investors can find many strategies predicted by historical data but it's far less frequent to be able to test actual recommendations. (Correlations can change over time and sometimes extrapolations from past data don't hold up.)

One of his more interesting observations is how many times over twenty year periods investors lost money owning long term corporate bonds. Rising interest rates (falling bond prices) from the 1950s into the 1980s had something to do with this, but Mr. O says that the twenty year bond rally (starting in the 1980s) is over and I agree with him.

How should we invest for the next twenty years? Drum role, please. Your equity portfolio should be 40% big cap value, 25% big cap growth and 35% small and mid-cap funds. Your fixed income component should be invested in intermediate term bond funds. Sounds like good advice (don't forget to invest some of your equity money in foreign funds) for any investor with a reasonable time horizon.

About The Author :

Bill Byrnes is co-founder of MUTUALdecision, a website providing mutual fund data, and the author of the MUTUALdecision Blog. He's been an investment banker with Alex. Brown

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