Portfolios Using Vanguard Mutual Funds

A number of our U.S. subscribers have asked us how we would implement our model target return portfolio solutions using just Vanguard mutual funds. This section responds to that request.

The following table shows the Vanguard Mutual Funds that correspond to the asset classes we use in our model portfolio solutions. Please note that we have tried to select the broadest based funds we could find. As we have discussed in our writing, in order to take "tilts" within these asset classes, investors may use other index or actively managed funds.

As you can see, there are a number of asset classes where Vanguard doesn't offer a product (yet).

The first is foreign currency bonds. In this case, we have used the no-load T. Rowe Price International Bond Fund, which has an annual expense charge of .91%. An alternative to this is the PIMCO unhedged foreign bond fund, which has an annual expense charge of .95%. In this case, however, we recommend only the "D" shares (PFBDX), which carry no-front end load and can be purchased through some mutual fund supermarket programs.

The second asset class where Vanguard lacks a product used in our model portfolios is foreign commercial property. In this case, we use either the Fidelity International Real Estate Fund (FIREX) or the Cohen and Steers International Realty Fund (IRFAX).

When it comes to commodities, Vanguard does not directly offer an index fund that tracks commodities as an asset class. However, it does offer two alternatives. The first is the Pimco Commodities Real Return Fund, which Vanguard offers through its funds supermarket program. This is a true index fund that tracks commodities as an asset class. Vanguard also offers an actively managed fund that focuses on energy-related stocks. However, as we have noted in more than one article we've written, energy equity funds suffer from two shortcomings versus "true" commodities index funds. First, the latter contains many more commodities than just energy. So energy funds provide narrower coverage of the asset class than a true commodity index fund. Second, because energy funds invest in the equity of companies that produce or use energy, rather than in the energy commodities themselves, the return on them can sometimes diverge from the return on a commodities fund when equity market conditions overwhelm energy market conditions. This has the unfortunate consequence of reducing diversification benefits just when a portfolio most needs them.

Another asset class which lacks a Vanguard fund is timber. To track the performance of our model portfolios, we use a market cap weighted mix of timber real estate investment trusts: 70% Plum Creek Timber (PCL) and 30% Rayonier (RYN).

Vanguard also thus far lacks a product offering in equity market neutral (our proxy for uncorrelated alpha strategies). In its place, we are using an equally weighted mix of five mutual funds that use “hedge fund-like” strategies. These include Hussman Strategic Growth (HSGFX), Analytic Global Long/Short (ANGLX), James Market Neutral (JAMNX), Rydex Absolute Return Strategies (RYMXQ), and JP Morgan Market Neutral (JMNAX).

The last asset class that is included in some of our model portfolios is U.S. equity market volatility, as tracked by the VIX index. Thus far, the only way to invest in this asset class is via futures contracts that track the VIX. Unfortunately, these are too complicated for most investors. We hope that at some point over the next two years, a futures-based index fund (similar to commodity index funds) becomes available in this asset class.

*Note that these are funds available to average investors. Those with more to invest may qualify for other share classes (e.g., Admiral shares).

Update: January, 2006