A roundup of investment news.
Best and Worst 529 Plans Chosen
Analyst Greg Brown recently unveiled Morningstar's best and worst 529 plans for this year, and the biggest news was how much the market's woes hurt Oppenheimer's offerings. Here's the list:
Best 529 College-Savings Plans
Ohio CollegeAdvantage 529 Savings Plan
Ohio is in an interesting position. The state has two plans at opposite ends of the quality spectrum, with this direct-sold plan securely in the "best" camp. One of the most important features of this plan is that the Ohio Tuition Trust Authority not only created the plan, but it also manages it directly.
Indiana CollegeChoice 529 Direct Savings Plan
This direct-sold plan is a newcomer to Morningstar's 529 best list. Upromise Investments--a subsidiary of the popular Upromise rewards program--took over this plan from J.P. Morgan in the fall of 2008 and upgraded it to a best-in-class choice for investors.
The Utah Educational Savings Plan Trust
For those who want a tax-sheltered way to save for college using Vanguard index funds, this is the plan. Utah's 529 plan has long been a favorite of ours and remains a strong choice for its low costs, flexibility, and tried-and-true Vanguard index funds.
Virginia Education Savings Trust and Virginia CollegeAmerica 529 Savings Plan
The final two plans are the only carry-overs from last year's best list. The Education Savings Trust has a lot in common with Ohio's direct-sold plan. Similar to the Buckeye plan, Virginia not only sponsors the plan but also manages it. The advisor-sold College-America plan remains a favorite for its large selection of mostly first-rate American Fund mutual funds that give investors access to a broad array of asset classes, including emerging markets, small-cap foreign stocks, and foreign fixed-income securities.
Worst 529 College-Savings Plans
Nebraska State Farm College Savings Plan
In November, this plan overhauled its underlying holdings with Oppenheimer mutual funds, and the timing couldn't have been worse. Just as Oppenheimer Core Bond entered the plan as a prominent fixed-income holding, it imploded, dragging down shareholder assets in both the plan's age-based options and its fixed-allocation options.
New Jersey Best 529 College Savings Plan
The first strike against this plan is its overly aggressive age-based option combined with a lack of flexibility. Even after a recent modification on April 1, the plan's single age-based option can still have up to 60% of assets in equities in the years just before enrollment and have up to 35% in equities when a beneficiary is enrolled in college.
Montana Pacific Life Funds 529
This is one of the least flexible plans around. Investors are offered only five fixed- allocation portfolios and a money market option. There are no age-based options, which is troubling given how popular these options are.
Ohio Putnam CollegeAdvantage
At the opposite end of the spectrum from Ohio's laudable direct-sold plan on our best list is this troubled college-savings plan. Similar to last year, we remain concerned about this plan mostly for its heavy exposure to Putnam funds.
Nebraska AIM College Savings Plan
Next to Ohio's Putnam plan, this is the only other holdover from last year's worst list. Few changes have occurred here, and the same problems--high fees and a lack of flexibility--still plague this plan.
Benefits of Including Commodities in a Portfolio
Recent market volatility has caused many investors to flee stocks for the relative safety of bonds and, in some cases, cash. What many investors may be unaware of is the role that commodities can play in an investment portfolio. According to Morningstar research and communications manager Jim Licato, history shows that by adding commodities to a balanced portfolio, risk was reduced without sacrificing potential return.
The accompanying image (view the related graphic here) illustrates the risk and return profiles of two investment portfolios over the past 20 years. Notice that by diversifying the original portfolio to include commodities, the overall risk of the portfolio, measured by standard deviation, was reduced drastically from 12.1% to 7.5%, while maintaining the same return of 8.6%.
Traditional assets and commodities generally do not react identically to the same economic or market stimuli. Analysis of historical data shows that commodities have negative correlation to bonds and low correlation to stocks. Therefore, combining these assets can often produce a more appealing risk and return trade-off.
In addition to the portfolio diversification benefit, commodities have other characteristics that make them an attractive asset class to include in a portfolio. Namely, commodity returns tend to increase in periods of high inflation. For example, when the demand for goods and services increases, their prices tend to increase. As a result, the prices of commodities used to produce these goods and services rise as well.
Commodities are often overlooked in an investor's asset-allocation decision. Adding a commodity allocation to your clients' portfolios could serve them well.
Deflation? Evidence Points to the Contrary
Goldman Sachs economist Jan Hatzius argued in March at the Morningstar Ibbotson Conference that deflation is likely. Many observers, including some bond fund managers, have also spoken about deflation being a long-term problem. Michele Gambera, the chief economist in the research group at Ibbotson Associates, doesn't agree, and he states his position in a post on MorningstarAdvisor.com's new Markets & Economy blog.
"What are the odds that we'll face an era of deflation? I say they're long," Gambera writes.
He says that there is evidence in inflation indexes that companies currently have some pricing power, which should ease deflation worries. True, the Consumer Price Index was negative (compared with 12 months earlier) in December, February, and March. (It was slightly positive in January.) "However, if we look at the so-called core CPI, prices have been stable around 1.7% to 1.8% during these months," Gambera writes. "This suggests that companies outside food and energy have pricing power." Also, the Personal Consumption Expenditure Index has experienced positive growth compared with a year ago, and the only components that have declined in price are motor vehicles, furniture, food, and energy goods. All other prices have been increasing. "Again, this suggests that companies in many sectors have pricing power," Gambera writes.
As a whole, the scale is tipping toward inflation coming back in the near future, Gambera says. How soon? "As soon as the economy gets back on its feet and the prices of food and energy return to their historical averages."
Rich Get Richer: Berkowitz's American Express Stake
Senior fund analyst Michael Breen saw another example of Bruce Berkowitz's investing acumen in a recent 13F filing. The filing shows Bruce Berkowitz's Fairholme Capital established a quarter of a billion dollar position in credit-card firm American Express AXP in late 2008. American Express' shares jumped after the firm beat Wall Street's diminished expectations, and they are up more than 45% for the year to date (as of May 6).
"Berkowitz isn't perfect, but he has had exceptional timing with most of his purchases and sales over the years," Breen writes in a post on the MorningstarAdvisor.com Markets & Economy blog. "I get paid to follow him, and you'd think I'd learn something along the way. But I bought American Express earlier in 2008 and I'm still underwater."
Gloomy Days for REITs
After the bankruptcy of General Growth GGWPQ--the biggest real estate investment trust bankruptcy so far--and attending a meeting put on by Morningstar's REIT team, Morningstar director of equity analysis Haywood Kelly sounded a warning on REITs. In a post on the MorningstarAdvisor.com Markets & Economy blog, he sums up Morningstar analysts' view of the industry.
"On average, we believe REITs warrant very high uncertainty (large margins of safety to our fair values before purchasing)," Kelly writes, "because of capital scarcity, leveraged balance sheets, development pipelines, joint ventures, falling rents and asset values, and general economic weakness."
Most REITs are no longer a reliable source of income, he writes, and if stock prices track fundamentals, it could be years before significant capital appreciation is realized.
"Investors must be selective when investing in this space. Bankruptcies appear likely," Kelly continues. "The point about REIT common shares being optionlike investments means these shares will be extremely volatile in 2009. They've rallied big over the past month, but could give up those gains in a heartbeat."
Seven Buffett-Inspired Funds We Believe In
Just in time for Berkshire Hathaway's annual meeting in May, senior fund analyst Michael Breen put together a list of funds that are true to Warren Buffett's investment principles and share his long-term commitment to shareholders.
This is the granddaddy of all Buffett-inspired funds. Bill Ruane and Richard Cunniff started Sequoia in 1970, mostly as a vehicle to absorb investors sent over by Buffett himself, who was folding his investment partnership. It has never wavered from the Graham-inspired underpinnings it shares with Buffett.
In late 2008, manager Bruce Berkowitz and his team remade this portfolio, loading up on pharmaceutical and defense stocks that had cratered on speculation about a new administration's policies. This fund got walloped in 2008, losing 29.7%. It's bounced back recently, and its record since its late 1999 inception remains great.
FAM Value FAMVX
Advisor Fenimore Asset Management has a record of success reaching back to 1974. Managers Thomas Putnam and John Fox stay in their circle of competence, buying high-quality firms with competitive advantages. Like Buffett, their favorite holding period is forever.
Weitz Partners Value WPVLX
Like Buffett, fellow Omaha resident Wally Weitz looks at market fluctuations as his friend. He's not shy about piling into troubled areas if he sees long-term value. He's made a few mistakes lately, but he's been right much more often than not over time.
Oak Value OAKVX
Managers David Carr and Larry Coats aren't cigar-butt investors. Like Buffett, they buy great companies at fair prices. Berkshire Hathaway is the fund's current top holding. But their circle of competence differs from Buffett's, so tech bellwethers Oracle ORCL and Microsoft MSFT also nestle in among the portfolio's top 10 names.
LKCM Equity LKEQX
Manager Luther King doesn't consider himself a Buffettologist. He just thinks firms with solid market positions, clean finances, strong cash flows, and good returns on capital are the only way to go. Still, this fund has a lot to offer.
Ariel Focus ARFFX
This young fund has been just average since its mid-2005 inception, but we think it will turn out fine over the long haul. Unlike Ariel's other Buffettesque offerings, it focuses on large-cap stocks. That's because managers Charles Bobrinskoy and Tim Fidler think more-liquid stocks best suit the fund's concentrated format.
Beware of Lead Balloons in Allocation Funds
Investors holding allocation funds have come to expect the funds' stock sleeves to be the main drivers of returns and for the funds' fixed-income sleeves to provide some ballast when the going gets rough, but fund analyst Michael Herbst sees some lead balloons in allocation fund managers' bond holdings.
Some missteps stem from relatively straightforward sources, Herbst says. Meaningful bets on nongovernment mortgage-backed securities have taken a toll on funds such as UBS Global Allocation BPGLX. Big stakes of beaten- down high-yield corporate bonds are weighing on the performance of the income-oriented funds in the conservative- and moderate-allocation categories, such as Evergreen Diversified Income Builder EKSAX.
At other funds, a combination of derivatives and cash equivalents has brought unanticipated and in some cases disastrous results, Herbst says. At AIM Basic Balanced BBLAX, the fixed-income team's decision to use derivatives to gain exposure to battered financial firms such as Lehman Brothers and mortgage insurer MBIA contributed to the fund's 40% loss. The team backing Oppenheimer Core Bond OPIGX and Oppenheimer Champion Income OPCHX made aggressive derivatives-based bets on a wider swath of corporate issuers and nongovernment commercial mortgage-backed securities, which have since decimated those funds. That pain spread into the bond portions of allocation offerings such as Oppenheimer Capital Income OPPEX and Oppenheimer Portfolio Series Conservative OACIX, which have suffered bottom-decile losses of 38% and 39%, respectively. A version of a derivatives/cash equivalents strategy has also burned the venerable Grantham, Mayo & Van Otterloo, which subadvises Evergreen Asset Allocation EAAFX.
Goldfarb Treading Lightly at Sequoia
Senior analyst Michael Breen recently spoke with Bob Goldfarb, veteran manager of Sequoia SEQUX, and Breen wrote that Goldfarb remains very cautious.
In a post on MorningstarAdvisor.com's Markets & Economy blog, Breen writes that Goldfarb and his team have bought three stocks lately, Caterpillar CAT, De La Rue DLAR, and Ritchie Brothers RBA. But they only put a combined 4% of assets in these new names and are maintaining an 18% cash hoard. Goldfarb says that they are struggling to figure out what normalized earnings should be going forward after a decade of excess profits. There certainly aren't survival issues with any of Sequoia's holdings. But he says that it's tough to get a handle on future earnings power and, in turn, intrinsic-value estimates for existing and prospective holdings alike.
"It struck me," Breen writes, "that the manager of one of the best funds ever, with a 35-year record of success, is treading lightly while others have been piling back into stocks. But Goldfarb has lived through more bear markets than most, and his cautious tone gives plenty of food for thought."