Posts Tagged ‘investment strategy’

The markets are down, making mutual funds all that much more important for risk averse investors. That is not to say stocks do not have their place, but the reason I love mutual funds so much is because they offer so much diversification (some would argue over-diversification) that risk becomes somewhat limited. So what does that mean for a mutual fund investor? It means greater participation in specialty funds like gold funds, small cap funds, BRIC funds, and so on. What this ultimately means for your every day investor is:

• yes, the markets will tank and bring down their investments. But when core investments drop, other investments hold down the fort. Which investments will it be? Bond funds? High Yield Investments? Small Cap funds? If I or anyone else could predict such things ahead of time, we would never both with those core holdings in the first place, would we? By being properly invested, the risk of being wrong is reduced or eliminated… something’s gotta win.
• opportunities to rebalance. Maintaining a proper asset mix is essential to long-term success (compared to chasing the winners every time a winner is identified). This means that as markets increase or decrease, the asset mix will shift. This calls for rebalancing, trimming those assets that have done well and dumping money into smart mutual funds that have not fared so well. This achieves two things: it reduces over-exposure and it allows to buy assets when they are considered “lower.”
• buy more when markets suck, buy less when they are heroic. This is the basis of dollar cost averaging, something we should probably stress more often at this site. Still, when markets tank, it reminds us of the importance of never throwing all of our money on the table at once. It reminds us to ease into a position(s) gradually.

Now what does this all mean to how I would invest 10,000? It means that if I was given $10,000 today and told that I had to invest it (instead of spending it on a bunch of toys for the summer), I would:

1. Determine my asset allocation model. You can do that right on this site if you want, or you can ask your advisor to help you figure it out for you. Mine will show: 60% Equities and 40% Income (this is after I decided to ignore the cash recommendation and invest instead in fixed income). Seems conservative unless I am a balanced investor, yes. But let’s take a closer look…
2. Research the following mutual funds; a good Balanced Fund like the PIMCO All Asset fund, which is a medium risk, high return 4-star rated fund. I would throw $7,500 at this fund because it is not only well managed, but the underlying assets are those that I actually believe in. And then I would invest in the Ivy Small Cap fund (a fund I have been laughed at for picking and sticking to, but one that maintains all of the fundamentals that I personally believe in and trust). This fund will allow me to invest $1,500 of the remaining $2,500, leaving me with $1,000 which I would throw at the Franklin MicroCap Value fund, another 4-star fund but one that has virtually no risk associated with it and a track record that would make old pros blush.
3. Review, review, review. Yes, three times.  Per month, that is. Because I think these assets are placed so well, the portfolio would fall out of balance fairly quickly.

If permitted, I would add a 4th point: split the $10,000 into ten $1,000 contributions. This would not be possible in the case of the funds I chose here, but if I had, say, $40,000 to invest, I would invest 10K now, the remaining $30K over the next 2 years. And all of it would be in mutual funds; small cap funds and a balanced fund, maintaining as close to a 60/40 split as I possible can given that balanced funds will not report in real-time what their holdings are.

It is about that time again where the Mutual Fund Site stresses the importance of asset allocation. This has very little to do with the recent market turbulence that has seen volatility (as measured by the VIX) jump to the highest levels of the year and more about how asset allocation accounts for more than 90% of one’s long-term performance track record. Regardless of whether mutual funds, exchange traded funds or any other asset management system are part of one’s investment strategy, asset mix is clearly important.

What else influences long term performance in an investment?

Other factors that influence a portfolio’s long term returns are asset selection, market timing and other factors (such as dollar cost averaging, expense ratios and so forth). But as shown here, none of those factors account for more than 5% of returns.

And here is why: the above factors involve investor intervention whereas asset allocation does not. An investor must consciously decide when to buy and sell (market timing), what assets to include (asset selection) yet asset allocation does not involve decision making.

Asset mix can be determined through a series of a questions like the handful of questions we ask on our Asset Allocation Model Builder. All the investor needs to do is stick to the asset mix recommended. Plain and simple; no emotion-driven investment decisions required unless it is for rebalancing or making higher level changes to the asset mix itself.

This is supported by the simple fact that many fund managers are better managers with their portfolios than we are with our own: we have an emotional investment in our savings whereas fund managers do not. Emotions cloud the logic that one needs in order to be a successful investor.

At more than 90% of a portfolio’s long-term returns, it is therefore well worth taking the time to review one’s asset allocation and making the appropriate changes to one’s investment portfolio. This is a no brainer, really.

A mutual fund’s expense ratios essentially tell an investor how much money the fund spends in terms of, well, expenses. And when all of us in the rest of the world are so concerned about expenses, how we spend our money, should we not be concerned about the way people who come up with our investment strategy spend theirs? Or does the expense ratio even matter, especially if the mutual fund itself provides spectacular returns?

There are plenty of arguments that suggest one over the other. And it makes sense that expenses, regardless of the business (whether you invest in mutual funds, equities, or even your own business), be kept under control. But in reality, a fund’s returns are measured post-expenses. Take the following as an example:

Fund A has an expense ratio of 1.25% yet its 3-year annualized rate of return is 12.5%. Fund B has an expense ratio of 0.55%, yet its 5-year annualized rate of return is just 8%. Is Fund A worth the premium, or is Fund B the better fund?

Measured strictly on rates of return (RoR), Fund A is the better performer. However, there could be many different considerations that need to come into question before deciding whether one should invest in Fund A or Fund B. Assuming each fund is in the same category and sub-category, one would have to consider the number of securities under management and the fund’s turnover ratio (the higher these numbers, the higher the expense should be), the level of risk (maybe a better performing fund is not what an investor wants if it means considerably more risk) and the tenure of management (a longer, more tenured management team suggests positive returns are more sustainable than a fund that has just recently returned good rates under a new management team).

Yes, these other considerations are the very reason for why sites like the Mutual Fund Site (a watered-down conversational site) and Morningstar (a straight, by-the-numbers site), etc., exist.

In our opinion, expense ratios do not matter when rates of return alone are an investor’s main concern. However, expense ratios do matter when one investigates why it is seemingly higher or lower than its competitors’. Because above the expenses, an investor needs to make sure that any mutual fund, regardless of expenses, aligns with his or her overall investment strategy.

To find get started, find out what your Asset Allocation Model is, right here at MutualFundSite.org.

It is not easy to find mutual funds that have earned double-digit returns on a year-to-date basis. But it seems that this small cap fund has done just that, earning 12.5% since January 2, 2010 even though its investment strategy might seems a little, well, unique compared to others in its category. But before we dig into three of its top 10 holdings, here is a small review of the ING Small Cap Opportunities Fund (NSPAX).

The ING Small Cap Opportunities A fund is a Small Cap Growth Fund with a great track record.

With just $109,500,000 under management, the ING Small Cap Opportunities fund has outperformed its category in 4 of the past 5 years, including its YTD returns. This coincides with Steve Salonek’s arrival on the fund in 2005, suggesting that the change in management at that time was a profitable change for ING.

In addition, this fund ranks in the Top Quartile for its YTD, 1, 3, and 5 year performance track record, another great achievement given how broad a category this is. Currently, Morningstar ranks this fund as having AVERAGE risk, and it has held this rating since Morningstar has started rating this fund. Currently, it has a risk-adjusted rating on this fund of just 3-stars, even though the fund has consistently held 4-star ratings in all periods except for its 10-year period where it held a 2-star rating, and its overall rating is, again, 3-stars.

On paper, this small cap mutual fund does not look all that inviting. But let’s take a closer look at its holdings. At the Mutual Fund Site we believe that the underlying portfolio of any mutual fund should motivate an investor into taking a long-term investment position, a short-term position, or no position at all. This highlights, therefore, the importance of portfolio, and in the case of the ING Small Cap Opportunities fund, the portfolio has a fairly aggressive (+18%) position in the Healthcare sector. Its next closest sector is the Software sector at 11.56% and third up is the Consumer Services Sector at 11.35%.

While Healthcare will certainly see its day, we believe it could be a little premature at this point to be so heavily invested in that sector when there are others that stand to see a quick, solid rebound with favorable economic news.

As a fund of just 145 underlying securities, this small cap mutual fund places relatively low importance on its top 10 holdings — which make up just a little more than 12% of the total holdings. In fact, its largest overall holding is a money market fund, and aside from that its first Healthcare security (at 1.28% of assets) is number 5 on the Top 10 list. At any rate, let’s take a look at 3 of its top 10…

1. Solera Holdings (1.47%). This company provides software and services to the insurance industry, assisting with the claims process. Overall, this industry is a growth industry given the increasing number of claims that insurers face on an annual basis — not including recent increases in fraudulent claims on account of the recession. With strong, consistent earnings growth over the past 3 years, it comes as little surprise that analysts polled by Thompson/First Call rate this stock as a strong buy.

2. Bally Technology (1.44%). Bally provides gaming machines and solutions for casinos. Although the company has seen a slight bounce in revenues since its 2007/8 levels, its Q1 levels are below 2009 Q1. We have commented elsewhere on whether gaming stocks are a good idea in our review of the Buffalo Micro Cap fund and the bottom line is that they should probably be avoided until economic data supports people spending and wasting money on this type of entertainment. We will elaborate here and warn investors that Bally Technology could be a long-term investment for this fund, a view that seems supported by the analysts at Yahoo!, this “HOLD” stock.

3. Gymboree Corporation (1.14%). As a children’s retailer, Gymboree operates over 620 retail stores in North America, competing with companies like GAP, Carters and the Children’s Store. This is some pretty stiff competition, yet Gymboree has weathered the economic storm extremely well. The company is very well managed, having achieved revenue growth over the past three years when so many others have suffered in this segment. Ultimately, we like Gymboree for its innovative branding and revenue growth in such tough periods. The biggest threats, which have been well documented, is the ease of entry into this segment from newcomers that may be able to offer similar product at a fraction of the price, not to mention alternate retailers who offer similar product — such as Wal-Mart.

Overall, the ING Small Cap Opportunities fund may be a small cap mutual fund that many people would be nervous about owning. However, with its AVERAGE risk rating and ABOVE AVERAGE returns, the fund has a well balanced portfolio in terms of risk diversification, as evidenced by its low concentration in its Top 10 holdings, the small/low percentage of total assets of its top 10, as well as its strong diversification (despite healthcare, as a whole representing nearly 1/5 of total holdings).

At the Mutual Fund Site, we like this small cap mutual fund and believe it would recommend it for investors who need a relatively neutral holding with smart investment management and good diversification.

There is a difference between investing in China and investing in China’s growth. This is a careful distinction that a lot of investors fail to make, yet it is a necessary one if one is seeking to profit from the undeniable growth that the Chinese people are expected to enjoy in the years to come.

Investing in China

The act of investing in China is the same as investing in domestic companies. The process involves narrowing down a large field of potential companies and ideas to a handful of prospects and then digging even deeper to determine whether that company meets fundamental basics to earn your investment.

These fundamentals would include such things as an appropriate equity level, satisfactory growth rates, margins and so on. The key difference is that such companies are actually based in China, so our everyday experience with them would be virtually non-existent (compared to investing in, say Wal-Mart or Ford or Apple, etc.).

Another key disadvantage to investing in foreign companies is that most people are unfamiliar with their political alliances, which becomes increasingly important in countries like China. To make an investment in a Chinese company, one should understand their political standing and how that bodes for their future growth and sustenance.

Investing in China’s Growth

In contrast to the above, investing in China’s growth is quite different. This involves taking positions in domestic companies that have the potential to profit from China’s growth. For example, companies that outsource key manufacturing processes would fall into this category. Such companies will be able to reduce their cost of goods sold (manufacturing costs) since labor in China is at a discount to domestic labor.

Another example would involve companies that are positioned to enjoy part of the expected growth in the middle class. This class historically creates a deeper demand for certain products and services, such as discretionary and luxury goods. Companies that have been allowed to establish a presence in China obviously stand to benefit from this and could offer great investment potential as well.

Summary

It is unquestionable that China is set to enjoy an aggressive growth rate in the years to come. Positioning one’s portfolio to take advantage of this growth is a little more complicated — does one invest directly in companies that have little relevance domestically and operate in a foreign political climate, or does one invest domestically in companies that have taken the steps necessary to enjoy part of this aggressive growth?

As often happens, the question becomes one of risk tolerance and investment knowledge. Knowing that there is a difference between the two surely helps.

It appears that a lot of people who find the Mutual Fund Site are looking for help with investing $10,000. Although we cannot “tell” people how to invest 10,000 dollars, we can certainly help them along in their investment journey, whether through our Free Asset Allocation Model service or our specific fund recommendations like our Small Cap Fund Top Pick for 2010 and our High Yield Investment Top Pick for 2010.

Ultimately, figuring out how to invest $10,000 (why 10K and not 20K or 50K, I don’t know) wisely will involve a lot more than visiting just this site. It will involve spending some time at Morningstar and sifting through the data there, particularly when it comes to your core holdings. It could also involve spending time at Fundalarm, a website that “warns” people about the fund they have invested in or are considering investing in. But first things first:

Start with your Asset Allocation Model

Knowing what your asset mix should look like will obviously provide a great starting point for all investors. Whether you are a Balanced investor, a Growth Focused investor or even an Income investor will tell you just how much money you should be “risking” in any given asset class, starting with Cash, then moving on up to Income and then finally Growth, with the risk levels increasing correspondingly. And then, if your risk tolerance allows it, consider specialty funds.

In fact. our Top Picks for 2010 are both specialty funds — the High Yield fund is not considered a core fixed income holding by any stretch (even though it offers a below average risk profile, it is still focused enough to fall outside the mainstream) and evidently our Small Cap Value fund is nowhere near being part of the main “Growth” class (even though it is consider low risk among its peers).

Once you have your asset allocation model figured out, you can further drill down and see how much of your $10,000 can be invested in the types of investments we look at fairly regularly. But keep in mind that the bulk of that investment should be in core holdings — a fixed income component, a growth component as well as (usually) a small cash component.

So, to get started simply click on the link titled “Asset Allocation Model Recommendation” as shown below:

Withing a couple of days, we will have your Free report to you so you can get started to see just how much of your $10,000 can be invested in which asset class and, of course, how much can go into those terrific specialty funds (whether they are the ones we recommend or not) that have the potential to improve your portfolio’s performance tremendously.

Best of luck and we hope to see you back again soon!

A little more than 3 months ago, the Mutual Fund Site provided a couple of firm recommendations on where mutual funds investors should invest their money. As far as we were concerned, these were exactly where to invest, even though our gut told us at the time that then-current market conditions made such a task rather difficult.

Those two funds were the Janus High Yield Fund as part of our Income Class recommendation and the Ivy Small Cap Value Fund as part of our Growth Asset Class.

To date, the Janus High Yield Fund has returned 4.37% YTD, a reasonably good return given all of the speculation and doubt surrounding the Income asset class these days. Are we satisfied with this return? With the performance?

Yes, indeed we are. The fund remains under the management of Gibson Smith and has stuck to its mandate. It remains invested primarily in mid-term, below investment-grade bonds (the average yield is a touch over 10%) and, well, provides investors with a positive rate of return. This is no easy task since, as we all expected, interest rates are on the move.

Our other fund, the Ivy Small Cap Value Fund, has returned 13.39% YTD. Some of the reasons this fund has performed so well could have something to do with Ivy’s overweightedness in financial services. However, we are not overly concerned that this fund is at risk the way most individual investors and some other funds are. The reason is simple: Ivy has invested in medium and small cap financial services firms. Dividend yield are strong (they would make GE and other financial firms look cheaper and greedier than they are) and many of the underlying assets have yet to enjoy the gains that the rest of the sector has thoroughly enjoyed recently.

Would we change anything?

No, not at this point. Both funds remain healthily below average in terms of the risk profiles versus their peers. And both have returned more to investor than anyone else would have expected at the start of the year (we even found some interesting trash talk on another, nameless website). Which bring us to the rest of the year…

We expect the Janus fund to handle the obstacles ahead with relative ease. They have performed well to date, but the challenges will keep Gibson busy.

We also believe that the Ivy Small Cap Value fund will face challenges, particularly when so many individual investors who have poured their money into these big bank stocks realize that the fundamentals are not there to support those price run-ups. However, the fact remains that the companies in which the Ivy fund has invested remain profitable and well capitalized with continued improvements to their equity positions through retained earnings. Overall, both funds are not only where to invest your money, but will continue to see some strong returns throughout the year.

When we look at the recent popularity of bank stocks, it is evident that a lot of people will get burned. The recent run up has resulted in higher volatility, which means that just as quickly as things have risen, they will drop. And up until the point that the prices really start to head south, someone will keep buying up these “popular” bank stocks. Everyone except the mutual funds who, for the most part, know better that to get sucked into the popular investment strategy when things rise, they will only keep rising.

Taking a contrarian investment approach like those we discussed elsewhere on this site might help.

Or it might not. After all, financial services firms remain relatively unpopular unless we are talking specifically about the “big banks,” the same stocks and companies that burned people in the past. But not all financial services firms are created equally. People who want to know where to invest their money might do well to examine the smaller firms, like those where Ivy Small Cap Value fund invests.

After all, our recommended Ivy Small Cap Value Fund has rewarded investors with a 13.39% return YTD.

Evidently, the folks at Ivy are doing something right, yet in their top 25 holdings you will not find any Citigroup, AIG, Fannie/Freddie, et al. holdings. Not a single one of them. In fact, they invest a large chunk of their assets in Small-cap stocks… not large, not Giant. (To a lesser extent, they invest in Medium cap securities, but as a small cap focused fund, they are pretty keen on sticking to their small-cap guns.

Given that less than 4 months of the year have passed, a 13.39% return (as at April 9, 2010) is pretty respectable. They know where to invest, no doubt about that, especially when it comes to investing in financial services firms. So, for those investors who have enjoyed the volatility rise and continue to pour money into some of these unsupported (fundamentally anyway) financial services firms, don’t let yourself get burned. Invest in a mutual fund that pays the pros to put your money where it belongs — in the right firms.

As a follow up to our former Contrarian Investment Practices post, we want to take a closer peek at exactly where to invest if these contrarian theories have any merit. Of course, we will look at mutual funds specifically.

In a recent article published by Russel Kinnel, the Director of Mutual Fund Research over at Morningstar.com, it became quite apparent that Contrarian Investment practices actually do work. The methodology that Kinnel used involved investing in funds that were seeing cash outflows (the “unloved” funds) rather than those funds that were deemed most popular based on the dollar amounts of inflows (the “loved” funds).

What Kinnel discovered was that investing in the unloved funds yield returns that were better than not only the “loved” funds returned, but the S&P 500 as well. In some cases, those “unloved” returns were substantially higher — 8.1% for 3 years versus the “loved” returns of 6.24% and the S&P returns of 6.96%.

The same trend holds for a five-year period as well, with the “unloved” mutual funds outperforming (8.08%) both the loved funds (4.25%) and the S&P 500 (5.76%).

The Question becomes one about finding out what the “unloved” are.

Finding out what the unloved funds are poses something more of a challenge. Kind as he is, Kinnel pointed out in his article that the “unloved” funds or categories were the large-cap growth, large-cap value as well as world stock. Easy enough to find the top performers in these categories; simply visit Morningstar.com and use their free fund screener.

But what about those times when finding these unloved categories is more difficult than finding them in an article so kindly published by someone like Kinnel? Well, let’s take a look at Kinnel’s statistics once again. In terms of best performing mutual funds, the following trend emerges quite easily:

• Unloved categories will outperform the Loved categories
• The S&P 500 will outperform the Loved categories, but not the Unloved categories.
• The Loved categories will not outperform either the Loved categories or the S&P 500.

So, if you cannot figure out what the “unloved” funds are (or even what the “loved” funds are for that matter, meaning you can’t figure out what to sell), there is one option. Consider that the S&P 500 outperforms exactly what your friends buying and likely what the advisors are recommending… why not buy Index Funds?

Index Funds might not beat out the top Unloved categories as a whole, but will definitely outperform what your advisor is recommending (or even what your friends are buying). This is particularly convenient if contrarian investing is something that investors are unable to fully agree with (e.g. cannot stomach being possibly wrong with their contrarian choices as they fluctuate and fail to return a positive number for a couple of years). While this is not the absolute best way to achieve the best returns, it definitely is where to invest if you do not want the hassle and potential expense associated with learning about mutual fund inflows and outflows.

An interesting philosophy exists, whether you invest in mutual funds or straight equities, that suggests we can all know where to invest if we go against the current rather than with it. In other words, if we adopt a contrarian mentality, we stand see some sold long-term gains in our portfolios. As an investment strategy, this is not always an easy thing to do. When you get into picking the best mutual funds, it becomes even tougher. (And of course if we are short-term traders, then it becomes virtually impossible).

So, where to invest…

Common sense and history tell us that if we all invest in a single asset, we drive the price of that asset up. Look at Oil in 2007. Look at Gold today. Look Apple shares. But the risk you run when you follow the herd is that you end up buying that asset somewhere near the peak of its price range, exposing your portfolio and investment to some serious and very real risks. For these reasons, we often try to find that diamond in the rough, that undiscovered security that is trading at a terribly low valuation — look at RIMM seven years ago, for instance, Teck Resources (TCK) even 1 year ago. Again, with the power of hindsight, we would all be retired by now, and we would all be millionaires.

With this “find the diamond in the rough” mentality, a couple of things can happen. One, we take on exaggerated risks because the assets we buy are simply cheap; they lack the fundamentals to support investing in them at all. The second thing that happens is that we hit a grand slam, we pick the right security at the right time when everyone else threw money at the latest and greatest Wall Street gem. The latter, of course, is an example of Contrarianism and this is exactly how we should invest, according to some.

What is Contrarianism?

This type of investment practice can mean a different things for different investors. The obvious interpretation is to sell when and what others are buying, and vice versa. It speaks to Warren Buffett’s famous quote: “Sell when others are greedy and buy when others are fearful” (not an exact quote, but the message is bang-on).

On a deeper level, it involves going in areas that others are ignoring. It means buying Citigroup (C) when it was trading at $1.02 and everyone else was not only ignoring it, but buying bonds at ridiculously low rates. It also means believing in the company’s fundamentals, trusting that the Board is doing the right thing by appointing Vikram Pandit after Charles Prince resigned (of course, each company will be different, the names will change but, in Bon Jovi’s words, the streets are the same).

It is in my opinion that this second type of Contrarian investment practice is the one we want to adopt as amateur, novice and even intermediate investors. Not only is it less risky (e.g. ignoring a strong asset class altogether and dumping money into unfavored classes even when fundamentals do not support it), but we can actually apply this practice to mutual funds purchases.

Now, understand that great websites like Morningstar have built tremendous intellectual capital, websites, and businesses doing exactly the opposite. That is to say that their models often favor top-performing funds where regular investors are flocking (this website’s Top Picks are great funds that Morningstar has ranked well, also). And other sites like FundAlarm also takes this view, ranking funds as “dangerous” if they fail to meet or exceed their group or category for three measurement periods.

But Contrarianism takes a different view. Often, the mutual funds you should invest in under this theory are those with net redemption figures, which are often triggered by poor performance track records that gets noticed by those two websites mentioned in the previous paragraph. Some Small Cap Funds like the Ivy fund (YTD return of 9.74%) we like, for example, invest heavily in small to medium cap financial services firms. Investing in this Ivy fund could certainly be considered a contrarian move; investing, on the other hand in the High Yield Investment fund that we recommend (YTD return of 3.80%), would not have been.

While both funds above are in completely different asset classes, they have both outperformed their peers, which leads to a natural question: do Contrarian Investment Practices really work?

The simple answer is: yes they do, especially with mutual funds.

(More to follow… check back soon as we take a deeper look into this interesting investment strategy and provide a tangible foundation to our argument).

In an article published at Bloomberg.com on March 18, 2010, it was noted that bonds issued by financial services firms like JP Morgan and Credit Suisse in particular came with rates that were substantially higher than rates in the general market. What this means for mutual funds and growth funds in particular is that there is plenty of opportunity in the financial services sector. Let’s take a closer look.

The Bloomberg article in questions makes it quite clear that the debt sold by banks, brokers and insurers returned 0.81% compared to the broader market’s return of 0.48%. This is a premium of more than 80% over what the broader market dictates. Consider this for a minute as we explore another interesting comment that was made in the article in question.

Brian Machan, a money manager at Aviva was quoted as saying that very few people are “underweight” in financials. This means that mutual funds are heavily buying up this debt. They are doing it because it looks attractive. The reason it might look attractive is that the yield is expected to drop, thereby increasing the value of those bonds on the open market.

The flip-side is that the financial services firms issuing this debt find rates attractive. This means they expect rates to increase in the future, allowing them to finance debt at today’s currently low rates. All indications support a rising interest rate environment; if ever there was a time to issue corporate debt now be that time (to the benefit of the borrower, that is).

Now, getting back to the premium paid by these financial services firms. Consider why they might need to raise this type of capital. It is cheap. Plus it helps finance a whole lot of plans. These banks have something up their sleeve and it is just around the corner by the look of things.

As far as growth funds are concerned, the mutual funds that are bullish on financial services such as the Ivy Small Cap fund we wrote about already or the Dryden fund we bragged about earlier, send a strong message to the investment community: financial services stocks are expected to outperform. This sure seems to be supported by the level of debt they are confidently raising right about now.

Other growth funds that invest heavily in financial services stocks include the FBR Small Cap Financial fund which has a history of LOW risk and above average returns. Morningstar rates it as a 5-star fund! Like the Ivy Small Cap fund that we touted as our Top Small Cap Pick for 2010, the FBR fund has a large interest in Iberiabank and East West Bancorp, regional banks that stand to substantially benefit from a positive shift in the economy.

Regardless of what type of mutual fund you choose, ensure that your growth funds have at least some exposure to the financial services sector. Whether they are smaller, regional financial companies like those held in the IVY or FBR mutual funds or larger banks like JP Morgan and Credit Suisse, the indications are quite clear that these firms expect to reap the profits and rewards of an economic turnaround that is just waiting to happen.

Ask nearly every professional mutual fund manager what they do for a living and their response might surprise you. While normal people like the rest of the world see (many) mutual funds as fine examples of investment strategy, security picking and so on, the professionals who pull the trigger on trades actually see their roles in the investment management quite differently. In fact, they see their jobs more as risk managers than investment managers.

Their view makes perfect sense, of course. They are risk managers, no question about that. Take the AIM Diversified Dividend Fund, a 5-star fund as measured by Morningstar. That fund has $1.5 Billion worth of other people’s money… you bet they are risk managers! If Meggan Walsh, who has been managing this big fund since 2003 thought otherwise, the fund would not have made the investments it has made, it would not have achieved the high returns it has enjoyed and it would not have done so with average or below average risk.

Risk is the investor’s greatest consideration when throwing money at a security.

Consider that — average or below average risk while achieving high returns. This is key because returns can be quite easy if one is willing to take the risks. And that risk is loss of capital. Which sounds simple in many ways, but how many of us felt that taking on risk was a reasonable thing to do before the market correction of 2007, 2008 (ouch) and the first quarter of 2009?

Even though higher risk is frequently synonymous with higher returns, we often forget that higher risk often means higher probability for loss. And those losses are very real when they happen.

So the recommendation is really to shift our thinking from high risk = high rewards to one where we aim to achieve above-average returns by taking on less than average risk for those returns. The idea is to achieve more than the risk levels dictate. That means earning 10% when the Beta or assumed risk suggests we should only enjoy returns of 7% or 8%.

To illustrate, consider high-risk derivatives. While it might be nice to achieve 5% returns, if you could achieve these returns with guaranteed and insured term deposits, why bother with the high risk derivatives? It makes little sense, right? But if we could achieve 10% returns with those same term deposits, why not give up the excitement of the market? (Of course, this rarely happens, so we have no choice but to accept that higher risk).

Mutual funds help us achieve above average returns while enjoying below average risk. This is because mutual funds so something many of us fail to do on our own — they diversify. (They also measure risk better than we do because they have the staff to analyze financial statements, perform site visits, call up management and so forth). Ultimately, diversification saves these mutual funds when risk rears its ugly head more than anything else — after all, no amount of analysis and over-management can eliminate market risk; but diversification can surely reduce all other risks.

While individual investors might opt for a dozen or so investments, mutual funds like the AIM fund quoted here, hold over 75.  And with 78% of those assets as large cap or giant cap, they really are achieving better returns for less risk. And this is important especially when markets sour. Again, referring to the AIM fund, its performance has outpaced the S&P 500 for its YTD, 1-year, 3-year and 5-year periods. The performance speaks for itself.

And this is just one fund. Most properly managed funds will evaluate risks and trade accordingly. The result? Those total returns outpace the broader market and, just as equally, other funds in its category. For investors this means less losses in market downturns and greater returns when the markets turn around.

In order to achieve long-term growth within your mutual funds portfolio it is believed you will need to incorporate a fairly significant amount of equity or growth funds. While this certainly seems to be a valid argument based on historical rates of return and the difficulty associated with accurate market timing, not all investors need to have a portfolio that consists entirely or primarily of growth mutual funds.

For highly risk averse investors, loading up on growth mutual funds would obviously be imprudent and no financial advisor, tenured or otherwise, would ever recommend doing so. But imprudent would also be ignoring the growth asset class entirely.

Now there is a way for investors to ensure that they eliminate equity risk in their portfolio, even while investing in the wildest, highest of high risk equity funds. They do this by finding a guaranteed investment, whether it is a quality bond, term deposit or other virtually or entirely risk-free investment and working out how much interest they will earn over the time horizon of their investment.

Let’s take a closer look at an investment that pays 5% per year. If you had $10,000 in total to invest and you wanted to make sure that it was guaranteed over ten years, you could actually invest $3,860 in high risk equity mutual funds that could return whatever the market allows. The remaining $6,140 would earn 5%.

But regardless of the performance of those equity funds, the remaining $6,140 invested in that guaranteed or extremely low-risk investment at 5% would be worth $10,000 after ten years. This allows you to invest $10,000 today and enjoy absolutely no risk at all. The catch? That you wait 10 years without touching the $6,140.

The worst-case scenario would see the equity mutual funds worthless after 10 years. The best-case scenario is that the return is greater than 5%, leaving you with more than if you invest $10,000 in its entirety in the guaranteed 5% investment. Realistically, you should expect a higher return. Even a 7.5% return on the equity fund would bump your portfolio’s performance from 5% to a little over 6%.

Might not seem like a lot, but 7.5% over 5 years is really a lower-risk equity fund. And, really, the point is not so much that you are now outperforming your friends, but that you are achieving that performance without any risk at all to your capital.

When we have so many mutual funds to choose from, we often get lost in some of the irrelevant details. We seem to want to chase the next trend, the biggest or hottest sectors and so on. Bond funds, value funds, dividend funds; we talk about these specific investments right here on our site just as planner do with their clients. If we were looking at economic figures, we would call it micro-economics. But when it comes to investments and mutual funds in particular, taking a macro-economic approach might actually help tell us about where investors should steer their money.

If we look globally, for example, we see that the Japanese Yen has been taking a hit over the last week or so because of that country’s position on interest rates. Unlike the US where the economy is (finally) starting to grow and rates have increased (Fed Funds Rate) and are expected to continue to increase, Japan is looking to reduce rates so that people will borrow and therefore buy more. While this fiscal policy will devalue their currency, the implications for Japanese corporations, particularly those that export their goods, are actually very positive.

In fact, a devaluation in currency combined with increased foreign spending will have a turbocharging effect on Japanese companies that report their financial results in Yen. Not only will sales revenue increase, but if foreign dollars are being used to purchase goods, the currency conversion results in a forex gain on the financial statements.

This could be a bad thing in the long-term. As the Yen stabilizes and starts gaining in value again, the company may have forex losses which can offset or more-than-offset stable or even climbing revenues.

What this means for mutual fund investors that is that Japanese-heavy value mutual funds might be a safe bet for shorter-term gains. Why? Because the premise of a value mutual fund is that the securities held within the portfolio are undervalued. This can be based on any number of criteria, but are normally price-to-earnings, price-to-book (value), price-to-cash and so on and so forth. Ultimately, the fund manager will determine whether to include a security in his or her value fund, but the qualifying criteria will come down to one thing: the security is underpriced.

This security, mind you, can be equity or income based. Right now, investors would gain either way. Japanese bonds can very easily increase in value if rates start dropping. Japanese equities can also increase, but it could take more time before revenues start to increase and translate in to balance sheet strength.

Our next step is pick a value mutual fund that meets our specific investment objectives (with time and risk as the driving force behind such a decision).

Now this is a top-down investment approach. It is how the Mutual Fund Site comes across mutual fund recommendations. A financial planner and/or investment advisor will work this way as well. Except they do this by also understanding your goals and matching up your goals and beliefs as best as they can to the macro-economic situation.

A long-term investors who has a decent appetite for risk will be ill-served to keep all of his or her investments in domestic securities. It normally “fits” to incorporate foreign or global investments into the plan. It never (or it should never) involve finding a value fund and then justifying a reason why it makes sense.

With that in mind, buying any kind of mutual fund because of a recommendation is often the wrong approach. Taking a bottom-down, birds-eye approach to your investments always makes more sense.

There are plenty of reasons why investors should steer away from mutual funds that invest in gold. While some mutual funds have performed well thanks to their gold holdings, there is a lot of concern among professional money managers that gold may have reached the end of the profit road.

It could be one of those situations where hindsight will tell us that the warnings signs were all to apparent. Here are some of them:

Consider the abundance of infomercials on television that ask people to send in their unused gold to be converted into “cash.” At these prices, many of these companies are able to turn a nice profit from all of that activity – in fact, they can even offer to pick up the tab on the courier expenses and insurance. The bottom line is that Gold is at a healthy, attractive price right now… if you are selling it.

…there are some fundamental reasons to steer clear of gold and gold funds

When it comes to investing in gold, one of the most active players are Exchange Traded Funds. Think about that. ETF’s, not central banks, not large financial institutions. What this tells us is that retail investors, who are investing in these ETF’s, are picking up Gold at prices that are so attractive that some of the largest countries in the world are offloading the metal at extremely lucrative prices. What Contrarian Profits.com points out is that when these investors decide to take a profit, the selling of gold by these exchange traded funds will push the price of gold down faster and farther than most expect.

And this makes a great deal of sense. Consider oil. The year was 2008, the month was July and oil touched $147.30, the highest it had ever seen. Since then, oil gradually fell (okay, that’s being polite: oil actually fell like a stone) to under $40 by November of that same year. This does no suggest that gold will suffer the same fate, but nobody expected crude oil to take such a drastic hit in such a short period of time. In fact, some analysts were calling for oil to hit $250 by the following summer (it never reached that).

Although they called crude oil the new “liquid gold” there are more than just rhetorical similarities between the two. First off, oil ran up as the economy reached its peak. Gold, on the other hand became a lot more overbought as the economy reached its trough and has begun to recover. For gold to remain in high demand, the economy needs to remain beaten down and all other inflation hedging investments lights currencies as well as other commodities become less attractive. Ultimately gold prices can be seen as highly sensitive and linked to the economic cycle.

Secondly, oil is a commodity, just as gold is. Just as oil supply is essentially limited and its production is controlled by OPEC, so too is gold supply controlled. In fact, gold production and supply is also shrinking. The point here is simply that arguments that gold will continues to see its prices climb in steady succession are unfounded and cannot be mistaken as fact, despite what some of the others are saying.

Essentially, the Mutual Fund Site believes that gold is expensive right now. We agree with Contrarian Profits that there are some fundamental reasons to steer clear of gold and gold funds that are heavily invested in the commodity, including some Gold ETFs. But because of this uncertainty, we also do not recommend taking a short position against the commodity either; it is best to sit this one out rather than endure a painful recovery process like those who, in the 1980’s bought Gold in the high $500’s and had to wait over fifteen (15) years for the prices to reach such highs again.