2 Positions For Capital Gains And Income In This Market

RSP is most representative of the top tier of those types of companies (as well as having exposure, to a lesser degree than the index itself, to the large multinationals.) RSP buys all 500 of the S&P 500 in equal amounts (not based upon a company’s capitalization). The fund then re-allocates quarterly if any company exceeds their 1/500th (0.20%) weighting in the portfolio.

There are disadvantages to this equal weighting; the S&P as measured by SPY (capitalization-weighted) tends to be heavier in tech, energy and consumer staples companies, while the equal weights are more “weighted” — simply because there are more companies at this capitalization level — in consumer discretionary, and financials. Of course, if I want representation in the US market at a time when rates are likely to rise, albeit slowly, and the economy likely to improve, albeit slowly, financials and consumer discretionary make a lot of sense.

Typically, RSP holds up better in bear markets but SPY excels in up markets. Yet, as the chart above showing results from the end of February 2009 demonstrates, over time that downside protection bias pays off! Over any long period of time, because it declines less in bear markets, RSP outshines SPY. In 2015, we believe we are better served by weighting all 500 of the S&P 500 equally. This gives us some exposure to the biggest firms but also the diversification of more mid-cap and smaller-cap (if you consider $2 billion small) firms. With its lowest-cap component coming in at $2.4 billion, I figure we’re getting a lot of mid-level domestic firms — just what we want this year.

At the other end of the spectrum are boring old bonds. Well… maybe not so boring this year. The fabulous rally in U.S. bonds over the last couple of years has taken place in the cradle of the Fed reducing rates and providing economic stimulus. That party is drawing to a close – in the USA.

In Japan, Europe and who knows where else next, however, they are just beginning to seriously reduce rates and stimulate their economies. They are where the US was 4 years ago. It is entirely possible that we might see as much return from developed-nation bonds in the coming months as we expect to see from an equity position in the US.

Please note, however, that we aren’t long PFODX because we think it will outperform the S&P 500 or SPY or RSP over any serious time frame; we own it because it serves to dampen the volatility of the S&P and our other equity positions. That’s what asset allocation is all about. If I’m correct and bond yields fall overseas, making existing bond holdings worth more, the capital gain will simply be the icing on the income and preservation cake.

The full name of PFODX is PIMCO Foreign Bond Fund (USD Hedged.) It’s the “USD Hedged” part that attracts us to this bond fund. There is no sense in buying foreign bonds for their higher yields at the same quality levels as their US counterparts if you are simply going to lose the additional income to currency conversion.

PFODX attempts to eliminate, and will likely at the very least significantly reduce, this fund’s exposure to the movement of currencies. That’s critical, given that the fund’s holdings are in Japan, the UK, Canada, euro-currency nations and Australia. PFODX sticks with the sovereign debt of the biggest developed nations, all of which yield more than their US equivalents, even after allowing for the costs of the financial futures they hedge with.