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VTINX: An Excellent ‘Set And Forget’ Retirement Income Fund

Summary VTINX is a fund-of-funds, but Vanguard does not charge any additional management fee. Globally diversified- about 30% equities, 70% fixed income. The fund’s ten year record puts in the top 10% of its peers. Morningstar has set up a group of mutual fund categories for Target-date retirement funds. These funds often appear in 401k and other retirement plans. A Target-date portfolio provides a diversified exposure to stocks, bonds, and cash for investors who have a specific scheduled retirement date. These portfolios aim to provide investors with an attractive level of return and risk, based solely on the target date. Over time, management adjusts the allocation among asset classes to more conservative mixes as the target date approaches. Morningstar divides target-date funds into the following categories: Target-Date 2000-2010 Target-Date 2011-2015 Target-Date 2016-2020 Target-Date 2021-2025 Target-Date 2026-2030 Target-Date 2031-2035 Target-Date 2036-2040 Target-Date 2041-2045 Target-Date 2050+ Retirement Income Many mutual fund families offer target-date mutual funds that roughly correspond to the Morningstar categories. For example, Vanguard currently offers twelve target-date funds: Target Retirement 2010, Target Retirement 2015, Target Retirement 2020, Target Retirement 2025, Target Retirement 2030, Target Retirement 2035, Target Retirement 2040, Target Retirement 2045, Target Retirement 2050, Target Retirement 2055, Target Retirement 2060, Target Retirement Income In theory, Target Retirement Income is the only one that is not supposed to continually change over time. Each of the other funds gradually evolves until seven years after their retirement income date when they are merged into Target Retirement Income. For example, Target Retirement 2020 will eventually resemble the Target Retirement Income fund in the year 2027. Of course, theory is not always the same as practice. In practice, Target Retirement Income has not been entirely static over the years. There have been several changes since inception: 2006: the allocation to stocks was increased from 20% to 30%, and three foreign stock funds were added. 2010: the allocation to foreign stocks was increased from 6% to 9%, and the three foreign stock funds were consolidated into Total International. 2013: A 14% position in Total International Bond was added, and Inflation-Protected Securities and Prime Money Market funds were dropped and replaced with Short-Term Inflation Index. 2015: The international equity allocation will increase from 30% to 40% of the equity allocation, and the international fixed income allocation will rise from 20% to 30% of nominal fixed income exposure. Overall Objective and Strategy The Target Retirement Income Fund is designed for investors already in retirement. The primary objective is current income with some capital appreciation. The fund currently invests in five Vanguard index funds. The fund holds approximately 30% of assets in equities and 70% in bonds. Fund Expenses The Vanguard Target Retirement Income Inv ( VTINX) is a fund-of-funds, but Vanguard does not change any management fee to assemble the funds for you. The expense ratio is 0.16% only because the five acquired funds. This is 67% lower than the average expense ratio of other mutual funds in this category. Minimum Investment VTINX has a minimum initial investment of $1,000. Past Performance VTINX is classified by Morningstar in the “Retirement Income” or RI category. Compared with other mutual funds in this category, VTINX has had solid performance, largely because of its low expenses. The fund is more defensive than most of its peers, and tends to outperform in weak markets like 2008, while underperforming in very strong years like 2009. These are the annual performance figures computed by Morningstar since 2005. VTINX Category (RS) Percentile Rank 2005 3.33% 3.30% 48 2006 6.38% 7.34% 56 2007 8.17% 4.46% 1 2008 -10.93% -18.06% 6 2009 14.28% 18.36% 80 2010 9.39% 8.94% 42 2011 5.25% 1.60% 9 2012 8.23% 9.01% 67 2013 5.87% 7.36% 56 2014 5.54% 4.36% 19 YTD -0.53% -1.99% 5 Last 5 Years 4.99% 3.67% 10 Source: Morningstar Ten Year Performance Graph VTINX – Current Portfolio Composition Vanguard Total Bond Market II Index Fund 37.3% Vanguard Total Stock Market Index Fund 18.0% Vanguard Short-Term Inflation-Protected Securities Index Fund 16.8% Vanguard Total International Bond Index Fund 16.0% Vanguard Total International Stock Index fund 11.9% The current SEC Yield is 2.06%. Mutual Fund Ratings Lipper Ranking : Funds are ranked based on total return within a universe of funds with similar investment objectives. The Lipper peer group is Income. 1 Yr#92 out of 587 funds 5 Yr#208 out of 457 funds 10 Yr#68 out of 266 funds Morningstar Ratings : The Morningstar category is Retirement Income Overall 4 stars Out of 144 funds 3 Yr 4 stars Out of 144 funds 5 Yr 4 stars Out of 132 funds 10 Yr 4 stars Out of 64 funds Fund Management The fund is managed by three individuals in Vanguard’s Equity Investment Group. Michael H. Buek, CFA, Principal William Coleman Walter Mejman Comments There is a lot of research showing that diversification across regions, asset classes and market capitalizations can enhance long term risk adjusted returns. That is a key idea behind Vanguard’s target date retirement funds which allocate funds according to expected returns and investor risk tolerance based on the number of years left until retirement. Diversification is also useful for those already retired. The Vanguard Target Retirement Income Fund provides a low cost, well diversified balance of income and growth. As of November 30, 2015, the fund had $10.58 billion invested. The fund’s fixed income holdings (around 70%) are well diversified including short, intermediate and long-term governments, agency and investment-grade corporate bonds. In addition, the fund owns inflation-protected, mortgage-backed and asset-backed securities and foreign bonds issued in non-U.S. currencies, but hedged by Vanguard to minimize currency exposure. The stock holdings (around 30%) are a diversified mix of U.S. and foreign stocks including large-caps, mid-caps and small caps. VTINX can serve very well as a core holding in a retirement account, and may also be used in taxable accounts by retired investors when IRA required minimum withdrawals are more than they need for living expenses. VTINX normally pays out quarterly distributions, but Vanguard allows you to set up your own automatic withdrawals as needed.

Hard Proof CEF Investors Are Irrational

Summary Closed-end funds offer significant opportunities for swing traders thanks to the irrational inflows/outflows of some investors. Recent movements in high yield CEFs, when compared to JNK and HYG, demonstrate how irrational the CEF world can be. While high risk, trading CEFs more aggressively can offer significant rewards if done properly–and significant losses if done poorly. Traditional money managers tend to dissuade clients from investing in closed-end funds, citing fees, the dangers of leverage, and the shrinking CEF universe as causes for concern. At the same time, income-hungry investors are rightly dissatisfied with the low-yielding income options in both the ETF and mutual fund universe, while the lack of leverage and stricter mandates of many of those funds limits their managers’ abilities to deliver high performance to clients. On top of that, CEFs have the unique value of trading sometimes at a steep discounts or premiums to NAV and diverging from historical average prices, providing opportunities to rotate in and out of CEFs to boost returns on top of providing a strong income stream. This is hard to do, and requires both diligence and knowledge. But it is also an excellent feature of the CEF universe that investors can use to their advantage. One other advantage of the CEF universe: many of the investors in these funds are slow to act and irrational. For the most part, this results in volatility and severe underperformance, as we have seen this year: (click to enlarge) But it also provides excellent mispricing opportunities that more savvy and diligent investors can take advantage of. This is especially the case with one fund: The Pimco High Income Fund (NYSE: PHK ), although its peers are showing signs of increasing divergence from their underlying investments, providing additional opportunities to swing trade these funds. Proof of Irrational PHK Investors There are many moments in the CEF universe that prove the irrationality of many market participants. The quasi-historical FOMC meeting and rate hike of last week is a phenomenal example of that irrationality-and the opportunity it provides. If we rewind three months, we see that there was relative stability in the world of high yield closed-end funds until quite recently: (click to enlarge) The Dreyfus High Yield Strategies Fund (NYSE: DHF ) and the Pioneer High Income Trust (NYSE: PHT ) remained relatively flat until earlier this month, when panic caused those funds and PHK to suffer steep declines. The fact that PHK continued to appreciate to a peak premium of 30% above NAV throughout October and November demonstrates the irrationality of many of the investors in this fund. This does not mean that I dislike it; on the contrary, it is one of the best managed and best performing (on a NAV basis) high income CEFs with one of the longest track records. But the way this strong performance attracts too much capital makes it a sometimes crowded trade worth betting against at peaks and buying at troughs. Proof of Irrational High Yield CEF Investors Recent history demonstrates that the other two funds do not have significantly more rational investors (probably because there is some overlap between them and PHK). Let’s look at three days of trading, starting with December 15th. This is shortly after the high yield panic caused by major headlines about redemptions and liquidity issues hit the entire high yield sector. (click to enlarge) Alongside the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ), our three high yield CEFs experienced strong price growth, with PHK outperforming significantly. The next day, the “high yield is oversold” narrative continued across the financial press, with commentators insisting this was a wonderful “buy-the-dip” opportunity, and the rising tide raised all boats again: (click to enlarge) Again DHF and PHK outperform significantly, bringing investors who bought the dip nearly double-digit capital gains in a couple short days. After the FOMC meeting and the historic decision to raise the Fed funds rate target by 25 basis points, the market’s sigh of relief was short-lived and equities sold off after a brief rally shortly after the announcement on Wednesday afternoon: (click to enlarge) Yet the high yield CEFs weren’t sold off at all. In fact, DHF and PHT saw a slight uptick and PHK was flat, indicating that some concern was trickling into these CEFs, but not enough to cause the sell-off seen in JNK and HYG. The short-term implications of this are clear: if JNK and HYG sell off again for another day or two, CEFs investors will likely panic and cause outsized declines. The selling opportunity will be obvious. But if the high yield market broadly fails to sell off, the irrational inflows into these high yield CEFs could turn into exuberance. Is it Time to Short PHK? With PHK up and JNK/HYG down, it seems a no-brainer to short PHK in anticipation of the inevitable cratering that PHK usually endures after a run-up. There are two reasons why this would be unwise right now. Firstly, the run-up in PHK happened over the course of a couple of days, which is rare for the name; historically, it runs up steadily over several weeks or months as inflows cause the premium to grow and grow. With that not being the case here, the price run-up is not founded on strong volumes and could not be victim to the typical outflow pattern of the past. Secondly, the technical indicate PHK could stay horizontal or even go up in the short term. Looking at the relative strength index (RSI) for the name, we see a sharp uptick in the last few days, but it remains at the lower end of the range it has seen since its dividend cut: (click to enlarge) And it is more in its mid-range historically: (click to enlarge) With a relatively modest RSI relative to the weakness in the high yield market, there is a possibility of a short-term decline but it is less obvious than in early November, when I sold out of the name, and in December, when I wish I’d shorted it. A Timeline to Act If now is not necessarily the time to short PHK, keeping track of the fund’s premium to NAV and the rate of change for HYG and JNK may provide a viable buy/sell signal to indicate when to act. Because it can take several days after a sharp move for a CEF to reset according to the market that it acts within, the divergence between high yield CEFs and the high yield bond market provides an opportunity for swing trading on a time frame of at least one week, and most likely several weeks. A quick look at when this month’s carnage began will demonstrate the timeframe with which to act and the signal to act on. (click to enlarge) The weakness in high yield began in earnest on December 7th, but was hinted at in the prior week on December 3rd. At the same time, the three high yield CEFs under consideration were up on average, indicating the beginning of a divergence: (click to enlarge) The sell signal was weak on the 3rd when the CEFs were on average up 1.44% and the high yield ETFs were down only slightly, but the sell signal got stronger on a second day of declines for ETFs and a second day for CEFs. The weakness in the junk ETFs only percolated into the CEFs on December 8th, and only really reached a level of significant declines the two days after, meaning a swing trader had four trading days (from the 3rd to the 8th) to sell off the high yield CEFs on the warning signal that they were becoming relatively overvalued to the ETFs that invest in the same underlying asset class. If we look at the last five days of trading, and note Monday’s weakness in high yield markets versus the strength in high yield CEFs at the same time, we can conclude that a similar week-long swing-trade opportunity is coming again: (click to enlarge) Conclusion A look at recent history shows how irrational the CEF universe is and how prone it is to volatility. This does not mean these funds should be avoided, but that they need an approach most income-seeking investors will not appreciate: more aggressive swing trading on weaknesses and strengths to fully take advantage of the opportunities the funds provide. If this sounds dangerous, that’s because it is; swing trading and rebalancing between CEFs will not only incur transaction costs and short-term capital gains taxes, but if done poorly will either lock investors into funds at too high of a price or will incur losses from poorly timed and executed trades. For instance, people who bought PHK in July and August when the fund showed comparative weakness faced massive losses after the surprise dividend cut in September. This is why the swing-trade approach to CEFs should only be done when investors have confidence and conviction in their understanding of the funds. If they can gain this perspective, the potential for very high returns by being a CEF contrarian is outstanding.

Why Does Dual Momentum Outperform?

Those who have read my momentum research papers, book, and this blog should know that simple dual momentum has handily and consistently outperformed buy-and-hold. The following chart shows the 10- year rolling excess return of our popular Global Equities Momentum (GEM) dual momentum model compared to a 70/30 S&P 500/U.S. bond benchmark [1] Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages for more information. GEM has always outperformed this benchmark and continues to do so now, although the amount of outperformance has varied considerably over time. In 1984 and 1997-2000, those who might have guessed that dual momentum had lost its mojo saw its dominance come roaring right back. In Chapter 4 of my book, I give a number of the explanations why momentum in general has worked so well and has even been called the “premier anomaly” by Fama and French. Simply put, reasons for the outperformance of momentum fall into two general categories: rational and behavioral. In the rational camp are those who believe that momentum earns higher returns because its risks are greater. That argument is harder to accept now that absolute momentum has clearly shown the ability to simultaneously provide higher returns and reduced risk exposure. The behavioral explanation for momentum centers on initial investor underreaction of prices to new information followed later by overreaction. Underreaction likely comes from anchoring, conservatism, and the slow diffusion of information, whereas overreaction is due to herding (the bandwagon effect), representativeness (assuming continuation of the present), and overconfidence. Price gains attract additional buying, which leads to more price gains. The same is true with respect to losses and continued selling. The herding instinct is one of the strongest forces in nature. It is what allows animals in nature to better survive predator attacks. It is built in to our brain chemistry and DNA as a powerful primordial instinct and is unlikely to ever disappear. Representativeness and overconfidence are also evident and prevalent when there are strong momentum-based trends.Investors’ risk aversion may decrease as they see prices rise and they become overconfident. Their risk aversion may similarly increase as prices fall and investors become more fearful. These aggregate psychological responses are also unlikely to change in the future. One can easily make a logical argument for the investor overreaction explanation of the momentum effect with individual stocks. Stocks can have high idiosyncratic volatility and be greatly influenced by news related items, such as earnings surprises, management changes, plant shutdowns, employee strikes, product recalls, supply chain disruptions, regulatory constraints, and litigation. A recent study by Heidari (2015) called, ” Over or Under? Momentum, Idiosyncratic Volatility and Overreaction “, looked into the investor under or overreaction question with respect to stocks and found evidence that supported the overreaction explanation as the source of momentum profits, especially when idiosyncratic volatility was high. A number of economic trends, not just stock prices, get overextended and then have to mean revert. The business cycle itself trends and mean reverts. Since the late 1980s, researchers have known that stock prices are long-term mean reverting [2]. Mean reversion supports the premise that stocks overreact and become overextended, which is what leads to their mean reversion. We will show that overreaction, in both bull and bear market environments, provides a good explanation for why dual momentum has worked so well compared to buy-and-hold. Dual Momentum Performance Earlier we posted Dual, Relative, & Absolute Momentum , which highlighted the difference between dual, relative, and absolute momentum. Here is a chart of our GEM model and its relative and absolute momentum components that were referenced in that post. GEM uses relative momentum to switch between U.S. and non-U.S. stocks, and absolute momentum to switch between stocks and bonds. Instructions on how to implement GEM are in my book, ‘ Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk’ . Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages, linked previously, for more information. Relative momentum provided almost 300 basis points more return than the underlying S&P 500 and MSCI ACWI ex-US indices. It did this by capturing profits from both indices rather than from just from a single one. We can tell from the above chart that some of these profits were due to price overreaction, since both indices pulled back sharply following strong run ups. Even though relative momentum can give us substantially increased profits, it does nothing to alleviate downside risk. Relative momentum volatility and maximum drawdown are comparable to the underlying indices themselves. However, we see in the above chart that absolute momentum applied to the S&P 500 created almost the same terminal wealth as relative momentum, and it did so with substantially less drawdown. Absolute momentum accomplished this by side stepping the severe downside bear market overreactions in stocks. As with relative momentum, there is ample evidence of price overreaction here, since there were sharp rebounds from oversold levels following most bear market lows. We see that overreaction comes into play twice with dual momentum. First, is when we exploit positive overreaction to earn higher profits from the strongest index selected by relative momentum. Trend following absolute momentum can help lock in these overreaction profits before the markets mean revert them away. Second is when we avoid negative overreaction by standing aside from stocks when absolute momentum identifies the trend of the market as being down. Based on this synergistic capturing of overreaction profits while avoiding overreaction losses, dual momentum produced twice the incremental return of relative momentum alone while maintaining the same stability as absolute momentum. We should keep in mind that stock market overreaction, as the driving force behind dual momentum, is not likely to disappear. Distribution of Returns Looking at things a little differently, the following histogram shows the distribution of rolling 12-month returns of GEM versus the S&P 500. We see that GEM has participated well in bull market upside gains while truncating left tail risk representing bear market losses. Dual momentum, in effect, converted market overreaction losses into profits. Market Environments We can also gain some insight by looking at the comparative performance of GEM and the S&P 500 during separate bull and bear market periods. BULL MKTS BEAR MKTS Date S&P 500 GEM Date S&P 500 GEM Jan 71-Dec 72 36.0 65.6 – – – Oct 74-Nov 80 198.3 103.3 Jan 73-Sep 74 -42.6 15.1 Aug 82-Aug 87 279.7 569.2 Dec 80-Jul 82 -16.5 16.0 Dec 87-Aug 00 816.6 730.5 Sep 87-Nov 87 -29.6 -15.1 Oct 02-Oct 07 108.3 181.6 Sep 00-Sep 02 -44.7 14.9 Mar 09-Nov15 225.7 89.4 Nov 07-Feb 09 -50.9 -13.1 Average Return 277.4 289.9 Average Return -36.9 3.6 Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages, linked previously, for more information. During bull markets, GEM produced an average return somewhat higher than the S&P 500. This meant that relative momentum earned more than absolute momentum gave up on those occasions when absolute momentum exited stocks prematurely and had to reenter stocks a month or several months later [3]. Relative momentum also overcame lost profits when trend-following absolute momentum temporarily kept GEM out of stocks as new bull markets were just getting started. Absolute momentum on its own can lag during bull markets, but relative momentum can alleviate the aggregate bull market underperformance of absolute momentum. Relative and absolute momentum therefore complement each other well in bull market environments. What really stand out though are the average profits that GEM earned in bear market environments when stocks lost an average of 37%. Absolute momentum, by side stepping bear market losses, is what accounted for much of GEM’s overall outperformance. Large losses require much larger gains to recover from those losses. For example, a 50% loss requires a subsequent 100% gain to get back to breakeven. By avoiding large losses in the first place, GEM has avoided being saddled with this kind of loss recovery burden. Warren Buffett was right when he said that the first (and second) rule of investing is to avoid losses. Increased profits through relative strength and loss avoidance through absolute momentum are only half the story though. Avoiding losses also contributes greatly to investor peace of mind and helps prevent us from becoming irrationally exuberant or uncomfortably depressed, which can lead to poor timing decisions. Not only does dual momentum help capture overreaction bull market profits and reduce overreaction bear market losses, but it gives us a disciplined framework to keep us from overreacting to the wild vagaries of the market. [1] GEM has been in stocks 70% of the time and in aggregate or intermediate government/credit bonds around 30% of the time since January 1971. See the Performance page of our website for more information. [2] See Poterba and Summers (1988) or Fama and French (1988). [3] Since January 1971, there have been 9 instances of absolute momentum causing GEM to exit stocks and then reenter them within the next 3 months, foregoing an average 3.1% difference in return.