March saw a divergence in performance.  Investors diverted assets from relatively safe but low-yielding bonds into riskier investments following last year's turmoil. Strong corporate earnings reports bolstered U.S. equity returns and large-cap, mid-cap, and small-cap stocks delivered respectable gains.  

Non-U.S. stock markets were modestly lower in March as investors digested large gains from January and February, and worried about slowing global economic growth especially in China. 

Emergency Market Equities have been a star performer so far in 2012 with indexes rising 16.6% in US dollar terms as of March 14th.

Emerging market economies are likely to grow faster than U.S., European and Japanese markets in the years to come. While a country’s economic growth does not necessarily correlate with it’s market performance as we discussed in our earlier article on emerging market allocation, emerging market equities are a valuable way to diversify your overall portfolio no matter your risk appetite.  For example, Portfolio Research’s risk controlled models currently allocates from 2% to 11.8% to emerging market equities.  But investing in stocks in China, Brazil and other exotic locations is not necessarily easy or cheap.  What is the easiest way for the average investor to diversify into emerging markets?

One of the most efficient ways to invest in this asset class is to buy the Vanguard MSCI Emerging Markets ETF (VWO).  The fund seeks to follow the MSCI Emerging Markets index, which tracks stocks in 21 developing nations.  The index is weighted by market capitalization.

There are various broad ETFs that efficiently index the full array of emerging markets.  iShares MSCI Emerging Market Index (EEM) also tracks the same MSCI index of 21 developing nations, and SPDR S&P Emerging Markets (GMM) which tracks the BMI index.  

Vanguard’s advantage is that the fund’s annual expense ratio of 0.22% is extremely low - significantly lower than iShare’s 0.69% fee, and much, much lower than actively managed emerging market funds like American Funds New World, which is the second largest emerging market fund and has an annual expense rato of 1.02%, and the Lippers Emerging Markets average expense ratio of 1.81%.

Far and away the most certain way to control your investment performance is to reduce your investment expense ratios.  Even a one-half percentage point variation in returns can make a huge difference in your wealth accumulation over time. 

Taking more risk was rewarded again in February.  Portfolio Research's highest risk RT15 Strategy gained 3.2%,  while our lowest risk RT2.5 Strategy rose 0.6%.

All five of our broad equity asset classes posted strong gains in February while fixed income assets struggled.  

Commodities jumped 6.1% thanks in part to rising oil prices.  Emerging Market Equities continued a strong 2012 performance rising 5.9% - on top of a 11.24% gain in January.    

TIPS and REITs (the 2011 asset class performance stars) both stumbled in February with TIPS dropping -0.3% and REITS declining -0.7%.     

Emerging Market Equities and US Small Caps (the asset classes which suffered the worst performance during the year 2011), enjoyed stunning increases in January: 11.24% and 7.07% respectively.

TIPS and REITs - 2011 asset class performance leaders - continued to rise in January.  Bonds and commodities managed to eke out small gains:

Stock markets are off to a strong start in 2012 with the S&P500 index up over 20% since early October, 2011. In fact most risky asset classes are performing well -

Given the improving economic data, accommodative Central Bank policies, low interest rates and declining market volatility, many conservative investors are wondering about shifting their core portfolios more rapidly from bonds to equity asset classes. 

In fact our models have seen such a shift to riskier asset classes in recent months, but we would interject a word of caution. One thing to note is how equity valuations are still relatively high by historic standards when using the cyclically adjusted ("Shiller") P/E calculation.  As noted in today's Financial Times, the current level of 22 times earnings is quite elevated, and a reversion to the mean could be a steep drop.

The financial service industry is shrinking – bankers, traders, and brokers are losing jobs en masse – but, remarkably, assets-under-management and fees for independent investment advisors have continued to grow steadily throughout the financial carnage of the past 5 years; as noted by the title of this article in last week’s Wall Street Journal – “It’s an RIA (Registered Investment Adviser) World, Everyone Else Just Lives in it”

Why are investors increasingly relying on investment advisors?

2011 was another dreadful year for actively managed funds (funds which seek to select individual winners and losers). Equity mutual funds had their worst year since 1997 relative to the Standard & Poor’s 500 Index, as record-high correlation and price swings made it harder for money managers to pick stocks according to Bloomberg.com. The 50-day correlation of S&P 500 stocks to gains or losses in the full index increased to a record 0.86 in October

What this means is that investors were better to put their money in broad index funds which track asset classes such as large-cap stocks, municipal bonds, or commodities. These asset classes soared and plummeted over the course of the year in tandem with the latest financial headlines, and with so much turmoil, most investors felt more comfortable going to bed at night knowing they were paying a professional to select and re-balance their portfolio of index funds.

But isn’t 1% still an awful lot to pay for asset allocation and a little hand-holding when markets are crashing?

 There is no question that experienced professional advice can be extraordinarily valuable for building a long-term financial plan and avoiding the behavioral finance pitfalls that plague the vast majority of individual investors. Most investors are likely to benefit from some form of outside financial assistance. But a fee based on 1% of your assets can add up to a staggering amount of your wealth over time (especially in today’s low-yield environment).

Asset allocation can be challenging (and those index funds aren’t going to pick themselves). But in 2012, with asset allocation models (ours and others) available on the internet, it is a very, very do-able task for the average investor to manage their own portfolio. Investors can accomplish much of the fund management services provided by investment advisors by following the set-up and re-balancing instructions from these web-based models and then making the suggested low-cost index fund trades through an online brokerage account or mutual fund company like Vanguard.  Investment Advisors can then be consulted on an hourly fee basis for periodic strategic planning and advice.  

Americans are zealously pursuing value in other areas of their lives from online coupons to do-it-yourself home repair.  So it is surprising how well the traditional Investment Adviser business and fee structure is holding up.

After suffering through wrenching volatility throughout 2011, investors in US Equities looking at their year-end statements find that the value of their portfolios were largely unchanged -- the S&P500 Index rose approximately 2% for the year.  Small-caps gained only 0.66% and the mid-cap index dropped -0.12%.  

These returns may not seem particularly rewarding given all the risk and volatility markets experienced. Surprisingly the US markets were relative winners in 2011 - global equity markets dropped almost 15% in 2011 and promising growth economies like India and Brazil saw their equity markets plummet by more than 20%.

An even bigger surprise in 2011 was the identity of the biggest winner among the 11 broad asset classes we track - TIPS (Treasury Inflation Protected Securities).   Who would have guessed that this conservative asset class - a hedge against inflation - would easily outperform riskier asset classes?  Especially given the largely benign inflation environment in 2011.

At the start of 2011 many advisers recommended moving away from bonds given the low returns and risk of rising interest rates. This would have likely proved a mistake for most investors given bond's relative strong performance among asset classes.

We expressed concern about emerging market allocations (in the context of asset allocation). We still have concerns about emerging market exposure, but we encourage investors to maintain their recommended allocation to emerging markets over the long-term. We also suggested conservative investors consider shortening the duration on their bond holdings - a move which would have reduced returns in 2011, but a move which we think remains prudent for 2012. TIPS low returns may seem even more absurd now, but TIPS remain an important component of our risk-controlled portfolios.

Volatility, as measured by VIX (CBOE's Volatility Index) dropped significantly in December, possibly signaling better equity market conditions ahead.  Volatility is one of the key drivers of Portfolio Research's allocation algorithm. This may be the light at end of the tunnel.  (Or it may be an approaching collision). Either way your best bet is a diversified portfolio.

December was a relatively quiet month for equity markets with the "Santa Claus Rally" failing to materialize amidst concerns about sovereign default in Europe.  The patterns we saw for all of calendar year 2011 -- Bonds out-performing Stocks,  US Large Caps out-performing smaller stocks, and international equity markets lagging badly -- continued for the month of December. 

November was a rough month for asset returns.  Most risky assets suffered losses in November, reversing a large chunk of October's rally. Hardest hit in November: emerging market stocks, developed world equities and US REITs. The only winners among our broadly defined list of major asset classes: Inflation-indexed Treasuries, which advanced 0.77% for the month and commodities, which eked out a 0.14% return.