The manic activity in the market recently has caused many mutual fund investors to question whether it’s time to reposition their portfolios.
For many the answer is yes -- but proceed with caution.
Jim Peterson, vice president and head of investment managerresearch in the Schwab Center for Financial Research, said the Federal Reserve’s recent cut in short-term interest rates was based on concern that there might be a severe slowdown in the economy. Therefore, “it’s not a bad idea to position your portfolio such that you can adequately handle an economic slowdown if that were to occur."
But what exactly does that mean?
Bond Basics
According to Peterson it means having a reasonable allocation to bond funds, specifically intermediate bond funds, which offer the best protection if the market were to slow down.
International bond funds may also be a good bet. That’s because if the dollar declines, as is widely anticipated, it could boost returns for funds that allocate assets to international bonds including, developed country bonds and emerging market debt.
Peterson said investors may also want to consider funds that have been positioned to weather the current problems in the economy such as the crisis in the subprime mortgage market. One such fund is the PIMCO Total Return fund.
Paul Herbert, a senior analyst with Morningstar believes that when it comes to bond funds, it’s a good idea to look at higher quality funds, such as diversified investment grade bond funds. Meanwhile, he added that investors should tread lightly in areas such as high yield, which have done well lately. Going forward investors won’t get as much yield for the risk as they would have a few years ago.
Home Equities
When it comes to investing in equity funds things get a little fuzzier.
Jeff Tjornehoj, senior research analyst with Lipper said the big question many investors are asking themselves is how defensive they want to be given what is happening with the economy. The economy has been revealing pockets of trouble, such as housing and the subprime mortgage markets, he said, adding however that data showing the economy is ready to topple over is still lacking.
Because of this uncertainty, Tjornehoj believes it’s likely “we are going to see pockets of leadership throughout the year.”
In terms of domestic equity funds, Schwab’s Peterson said domestic equity is pretty efficient, which makes it tough to “hit a home run” when the markets are rising dramatically. “But you can do well vis-à-vis a benchmark by not letting your portfolio get hurt as bad if the economy slows more than expected.”
In general, Peterson is tilted toward funds that invest in more quality stocks, and those with a more defensive nature. One area in particular that Peterson favors is domestic dividend-focused equity funds.
International Flair
Investors should also have an allocation to international equities. The weak dollar – not to mention the cut in interest rates that portends a weak dollar ahead –is good for international stock funds. Some investors are putting money in international funds as a hedge against the dollar, to make money even as the dollar declines.
Peterson recommends having about 25 percent of your equity allocation invested in international equities. Within the international space, he generally looks for more growth opportunities. This can include having a small allocation – for instance, 5 percent of your equity allocation – in more risky international asset classes such as emerging markets.
When looking at equity funds, Morningstar’s Herbert advises investors to stick with funds that are more core, stable investments. Domestically, this could be a diversified large cap fund or if you are looking internationally, perhaps a foreign large cap blend fund.
Herbert isn’t a big fan of sector funds, saying “I think investors sometimes spend too much time thinking about sectors,” which are often more expensive and tend to be more volatile because they are more concentrated.
However, he adds, that some of the areas that do seem to be cheap right now relative to fair value include homebuilders, building construction and financials.
Lipper’s Tjornehoj adds that the energy sector has a good shot at performing well through the end of the year. Given the weak dollar, investors might see the energy sector as very stable, he said.
While there are always investment opportunities to be found, financial professionals across the board agree it is important to resist the temptation to make major changes to your portfolio based on short-term fluctuations in the market.
While it is good to review your portfolio to make sure you are still comfortable with your level of risk, it is important to have a good long-term asset allocation strategy in place and try to adhere to it as much as possible.
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