FSO Editorials: Once More With Feeling by Robert B. Gordon 07/19/2004

Once More With Feeling
A Review Plus Some New Ideas
by Robert B. Gordon, Sc. D.
July 19, 2004

We’re going to discuss some more ways to build mutual funds into interesting and almost certainly profitable portfolios in the future. I say that because I am picking the "cream of the crop" in several different categories. With great proven records in their specialty and expert managers, the fund prices may dip in the coming market down leg, but as we have shown in the past, these dips can be turned into profits in the next upturn thru rebalancing.

I love what I have been doing in preparation for this paper, spending hours in Morningstar’s review pages followed by more viewing of my FastTrack charts tm. My favorites have long, smooth up-rising price curves that appear to offer good returns for years in the future. But there are other ways some people attempt to get rich much faster. I scanned a report of the countries 200 fastest growing funds, some with very little money and so new their prices were not yet available in the newspaper. A tiny number will survive the bear market and most will perish. Please do not ask for the name of the report as I threw it away.

As a follow-on to our last report, I am going to review some old ground previously covered as well as new ideas here. I am constantly reminded from e-mails of the tremendous spread in ages and family responsibilities among our readership with singles of 20 and 80 and every other kind in between. So I will continue to illustrate small portfolios, large portfolios, simple examples and more complex examples so that nearly every reader can find one to consider for his or her own situation.

First about the risk of losing money, we cannot give any numbers but we can tell a risky portfolio from those that are considerably safer. The first criterion in building a portfolio is the percentage of the stable components which are always the safest in any market. We have arbitrarily said that it should be at least 50% of the total portfolio unless the investor understands and wants to assume greater risk. With 64 years of market experience I can afford to build a portfolio with only 40% stable elements. So could a very young person just starting out. But a retired person who cannot replace a loss may need 70 or 80% of stable elements. We will give examples covering this range later. This is the first decision to make.

The remaining 20 to 60% of the portfolio is the part with which you hope to grow profits over future years, not one or two or three or four but perhaps five with some luck. I have been telling my readers for 3 years that we are facing a severe bear market and it is just about to start. That little dip in 2001 and 2002 was just a practice run which caused 7 trillions of dollars to be lost.

Over the past year, we have given numerous portfolio examples containing some quite volatile funds and stocks, primarily in the precious metals and natural resource areas. The stocks, especially, can be very volatile and profitable if chosen wisely. For this report, we will not include any stocks or highly volatile funds, except for some short funds in several portfolios. It is true that short funds can be quite volatile but they are very different from all other volatile funds whose ups and downs are usually quite unpredictable. On the other hand, all reverse index short funds are very predictable because they behave just opposite to their chosen market index. This is as predictable as the sun shining after the rain clouds leave. This prominent type of short funds always goes down in up markets and rises in down markets, as surely as the sun rises and sets in Arizona 365 days and more in leap year.

Now, although the stable assets may not make as many profits as the other classes, they are absolutely vital to the success of all the other classes. How can this be? Very simple, they supply the assets to transfer to more volatile classes when they are lower in price and increases their profits in the next market rally. They also supply the safe reserve to which profits from other classes are always transferred for preservation.

In our most recent essay, we added a new asset class, American mutual funds owning foreign equities. [See] In my recent revue of these funds in Morningstar, I was surprised to find many good funds closed to new investors which means they cannot find enough good stocks to buy right now. And other funds had huge amounts up to 5 million dollars to open an account. However, we did find several funds which we will partly identify and then leave the rest to you and t depend on me because I may not be here when you need help in the future.Morningstar. Please understand it is very important that you learn to use their screener and that at Yahoo and Bloomberg. You canno

So, a complete current listing of asset classes for use in our portfolios would be as follows:

Stable Assets
     Hussman Hedged Growth fund
     Hussman Hedged Income fund
     Short Term U.S. Treasury Bond funds
     Short Term Foreign "          "        "

Long Term Stable Assets
     Permanent Portfolio fund
     FP Crescent Fund
     Selected 5 Star Conservative Alloc. Funds
     Selected 5 Star Moderate Allocation    "
     Selected Conservative Stks: PCL, WTR

Volatile Funds and Stocks
     Precious Metals
     Natural Resource
     Energy

We will briefly discuss the five classes before moving on to some illustrative portfolios. The two Hussman funds are the only ones that can be considered really stable due to their hedging activities. The Treasury and Foreign Government bond funds have been quite stable so far but will have to be followed closely to catch any changes. The stocks and funds in the Long Term Stable Category are subject to periodic price dips but should be stable over the long term. Hence they should be suitable for investors with a horizon of twenty or more years. The new category of American funds holding foreign stocks have about the same stability unless their economies are in a different cycle than the United States. That is why we put them in their own asset class.

Volatile stocks not only have volatile prices but may have irregular price cycles that are difficult to forecast and manage. They will not be discussed further here but have been covered and illustrated in many previous essays, We will discuss the short funds and illustrate their use since they are predictable and can be a very valuable portion of any portfolio whose manager has the interest and time available to collect profits from their actions. Just remember that when the overall market goes down, these funds go up and it is always good in bear markets to own something that can go up.

     Stable Assets
           HSGFX Hedged growth    40%
           HSTRX Hedged Income    35%
                Sub Total                   75%

     Long Term Stable
           FCAPX                             8%
           DOD_X   *                         8%
               Sub total                     16%

The Hussman funds have never been in a loss position yet so I’ll give them 3/4 of this super safe portfollio. The Long Term Stable group holds small quantities of two seasoned funds under great leadership. I am giving three letters of the fund name which should be easy to find in Morningstar’s group of 4 and 5 star funds in the moderate allocation category. To help keep this portfolio in the black, we put 9% is the most conservative of all short index funds, the S&P500 Index. The simplest was to capture the short profits is simply to sell the short fund at the market bottom and buy it again at the next market top. There is nothing easier than that.

     Long Term Stable
           FCAPX                            10%
           DOD_X *                         10%
           BER_X *                         10%
               Sub total                      30%

       Short Funds
            Reverse Nasdaq              10%
            Reverse S&P500             10%
                Sub total                     20%

Now we spread this moderate portfolio over 4 superb funds, two with names and two to find in the Morningstar Conservative or Moderate Allocation category which includes stock and bond funds in a normal market and more bonds than stock in the present market. The better funds in this group are now holding significant amounts of cash as protection in the bear market leg now just starting.

We use 10% each of two reverse index funds which will surely bring significant gains in the future market down legs. These gain should definitely be taken as close to the bottom as possible and transferred to the other funds. Then, at the next market top, a rebalancing should add assets to the short funds to increase their gains in the next leg down. Once an investor gets the hang of this simple asset transfer, it is almost like coining money.

For our third example we will present and discuss a moderately aggressive portfolio with the addition of two funds holding foreign stocks.

     Long Term Stable
           FPACX                             10%
           DOD_X *                          10%
               Sub total                      20%

     Foreign Stocks
           FDI_X    *                         7.5%
           JGV_X   *                         7.5%
                Sub Total                    15%

     Short Funds
            Reverse Nasdaq              10%
            Reverse S&P500             10%
                Sub total                     20%

We present and discuss a fund idea that is definitely not for everyone. It is a further extension of the third fund example above. It’s success will depend heavily on making timely rebalances at each market bottom and top. In this huge Grand Supercycle bear market, progress is occurring slowly. It has taken four years to complete the first down and up cycle so we can anticipate more of the same.

I have spent more time researching this portfolio than any other in my memory because of the problem of finding two small cap stocks to complete the portfolio. I required all ten stocks to have 5 star performance, experienced management and reasonable purchase requirements. The latter factor was difficult since many good funds were closed or raising entry purchase levels. There is a very limited amount of small cap stocks and funds so I am giving the name of an extra fund in case it is needed.

First of all, we will list the 5 star funds by categories of securities they hold:

HSGFX, the Hussman Growth fund is the only stable equity fund we know. It has a high probabilit.y of not losing money

We list 3 funds in Morningstar’s Moderate Allocation category. They hold stocks and bonds but are now holding less stocks and more cash. We use two in the portfolio and one is a spare if needed: FPACX, DOD_ X, and BER_X. Fourth letter is blank for you to find.

We list 3 funds in the Small Cap category after a very lengthy search in Morningstar to fill the two portfolio positions: FBR_X, RSP_X and PSC_X. Again, the 4th letters are missing.

After a large search we list two funds in the Foreign stock category, one quite large and one quite small in size: FDI_X and JGV_X. Please find the blank letters.

Finally, we come to a very important portfolio segment - Short Funds. We select 3 of our old favorites: BEARX, RYURX and RYAIX in order to have a fully managed fund in BEARX and reverse funds for the S&P500 and Nasdaq 100.

We have left the blank letters in the new funds, not to infuriate you, but to get you to use the search capability at Morningstar, Bloomberg or Yahoo. We feel that anyone who puts his or her money into a group of funds, should at least look at their price chart over recent years.

We will now go to a presentation and discussion of the portfolio using 10 highly diversified funds, all holding the distinctive Morningstar 5 star achievement.

     DOD_X - Moderate Allocation    10%
     FPACX         "                "        10%
                                   Total         20%

     FBR_X - Small Cap Gwth.         10%
     RSP_X       "       "     Blend       10%
                                    Total         20%

      FDI_X - Large Cap Foreign        10%
      JGV_X - Small   "       "             10%
                                     Total         20%

      BEARX - Managed short            10%
      RYURX - Reverse S&P500         10%
      RYAIX -   Reverse Nasdaq100    10%
                                      Total        30%

So the portfolio has 60% of growth stocks, half of which we allocate to stable which gives a total of 40% stable in the overall portfolio. We will call this a "gentlemen’s risk" which is definitely not for everyone. But anyone of either sex who has several years of bear market experience should be able to manage this interesting growth portfolio.

Since we are now experiencing the start of the second bear market leg, we face the possibility of 4 funds rising and 6 funds falling in price as the months go by. However, an effective rebalancing at the market bottom will shift assets from HSGFX and the 3 short funds to the 6 growth funds. This will of course add to their gains during the bear rally phase. So, after the full down and up cycle the portfolio may have a meaningful profit. Then, a rebalancing at the next top will shift money from the 6 stocks to HSGFX and the 3 bear funds which will then be more profitable on the next down cycle. This is not at all "iffy" as its assured to happen by the characteristics of the chosen funds.

In a tax-free account, this portfolio will require $10,000 initial capital which should do very well in experienced hands. We will be happy to hear from anyone with questions about this suggested portfolio.

THREE-YEAR ANNUALIZED GROWTH PERFORMANCE 07/14/2001 to 07/14/2004
Stable Funds	Percent	Gain	Weighted Percent
HSGFX - Stable Growth	10%	15.3%	1.5%
DOD_X - Moderate Allocation	10%	8.2%	0.8%
FPACX - Moderate Allocation	10%	14.3%	1.4%
Total	20%		2.2%
FBR_X - Small Cap Growth	10%	19.9%	2.0%
RSP_X - Small Cap Blend	10%	21.2%	2.1%
Total	20%		4.1%
FDI_X - Large Cap Foreign	10%	9.7%	1.0%
JGV_X - Small Cap Foreign	10%	14.7%	1.5%
Total	20%		2.5%
BEARX - Managed Short	10%	14.7%	1.5%
RYURX - Reverse S&P 500	10%	-1.0%	-0.1%
RYAIX - Reverse Nasdaq 100	10%	-3.4%	-0.3%
Total	30%		1.1%
Grand Total	100%	NA	11.4%

The performance above is without any rebalancing. Looking at the charts of the short funds over the past four years, one sees very sharp, parabolic peaks that can be easily recognized. They occurred on these dates: April 2001 (minor), September 2001 (major). October 2002 (very major) and finally a minor one in November 2003 shown only in BEARX and possibly due to their gold holding. But an even easier and possibly better way to schedule the rebalancing is just to watch for a top in the price of the 3 short funds at the market bottom and a maximum in the price of the 6 growth funds at the next market top. Please remember, the bottoms may sometimes be rather sharp but the tops are usually very broad so you can schedule a long vacation at the top.

The opportunities for gains from rebalancing are far greater in this portfolio due to the two groups of major funds. First, the 30% bear funds gain sharply in value in every bear phase of the market, without question. Second, the 60% growth funds can make large gains. In the 2003 rally, many of these funds gained 40 or 50%. which would have been transferred in rebalancing to increase the assets of the short funds at the market top. As a result the gains of the short funds in the 2004 bear leg would then have been increased. This is a built-in feature of this portfolio. Each group gains on alternate market legs. Since this alternation in growth of the longs and shorts is a known feature of a large bear market, it will surely occur and needs only recognition of the times to rebalance the profits at the bottom and top of the market.

So, this is not intended as a learning portfolio as it definitely needs some management experience. There is nothing to do 99% of the time except watch the profits of either the short funds or the growth funds pile up. The rebalancing is best done at a low cost broker by simply selling the ten funds and re buying them in the new dollar amounts. I can do this at Brownco since each trade costs only $5, or $100 to sell and re buy the ten funds. They do have a $15,000 minimum to open an account.

Like most all of our many portfolios, this ten fund portfolio is permanent so long as the ten funds continue their present policies which are unlikely to change. We have done the work in researching these funds to select superior fund records, experienced managers and great diversity. Every fund is different from the others and so is each of the funds in each group. This almost guarantees that the portfolio will capture every nuance in the small changes that occur in all stock and bond markets. We can’t claim perfection but almost near to it, at least in this world.

This is by far the most interesting portfolio suggestion I have made to date since the market actions of all ten funds are well known in advance. The job of the investor is to recognize the market bottom and top and to rebalance in a timely manner and take the profits via a portfolio rebalancing action.

A note to new readers, there is a large amount of additional material in previous essays on our portfolios planned for profitable rebalancing plus much useful material for new investors whom we welcome. We are constantly looking for more and better funds for our portfolios and do invite suggestions from our readers. Go to our archive using the link at the end of this paper.

Since only a small percentage of our readers are apt to build the ten fund portfolio featured in this essay, we wish to remind our many readers of any age that we are not abandoning them. Earlier in this issue, we gave our first two portfolio examples, either of which would make a good starter portfolio for investors of most any age.

In the nearly three years we have been writing on the internet, we have been insisting on funds of the highest caliber and portfolios properly balanced in the various manners we have described. We do publish new ideas and variations of the old. We study the market and mutual funds many hours each day as it is our major activity. Even while we are writing we have CNBC on mute.

We welcome your ideas, both pro and con ours, and wish all readers the best of investing success.

Stocks have definitely finished their first wave 1 and 2 down and are now in wave 3, usually the longest of 5. One of these days, without warning, we will probably have a precipitous drop, which will draw an interest from the investor masses. What they will then do is unpredictable, but will probably not involve much selling.

Gold has just about finished its wave 2 up and is about to start wave 3 down. If and when it drops below 370, the former wave 1 low, it will surely bring screams from the bulls.