Value Weighted Index Funds and Multiple Asset Index Fund Part 1

The appeal of mutual funds isn’t what it used to be. As such peoople creating mutual funds are getting more creative about how they do it. The release of exchange traded funds or ETFs has ushered in a new era of investing in passive, low fee investments. It’s very easy to package together a few ETFs and instantly have your own mutual fund by owning just 5 securities. Previously if you wanted to mimic your own mutual fund you would have to buy hundreds of securities.

This article will first talk about the changes in the mutual fund and ETF industry, why they are benneficial and how you can make your own.

To start with the article will focus on two types of new funds. Multiple asset funds, and value weighted funds.

Value weighted funds might take a group of 1000 of the largest market cap stocks and based on the value indicator(s) they will have more of the stocks that are more undervalued. For example, if the “earnings yield of 5 stocks is 20%, 15% and the remaining in 10% the way to determine the asset allocation would be to add 20 plus 15 plus 10 plus 10 plus 10 which is 65 and to divide each security’s yield by 65. So the stock yielding 25 should be weighted so 30.7% of cash is allocated towards it. The one with 15% yield should have 23.1% and the reamining 3 should have 15.3% roughly. Every so often after major changes in 0prices, you rebalance the index. This has the effect of profiting from the volatility, but is weighted heavily on where you expect the price gains to come from. Buffett basically invest sand uses this principal to some extent because he owns 25% of his portfolio allocated towards cocacola and 20% to Wells Fargo, so he definately believes in investing more aggressively in the companies you believe in. However value weighted index spreads your capital more thinly across more names so the effect is not as extreme and the returns are generally more stable unless the entire market is in a bear market.

Joel Greenblatt talks about this value weighted indexing extensively in his book “the big secret for the small investor”. Of course Joel Greenblatt manages Gotham capital and he gives a plug to his website where he says he will provided updates and in fact gives you two funds as seen here. The two funds are FVVAX and FNVAX.

One of the errors or “flaws” of this investment method is that it is always investing in the stock market. Significant movements of cash, or significant inflation or deflation may pose a threat to this portfolio. Also, there’s no way of decreasing your overall stock market exposure during any time unless you independently add and subtract shares and have cash on the side yourself. Additionally, what if there is a huge bear market when you are going to need your money the most?

I believe a great compliment to this type of weighted index funds investing is multiple asset index fund investing. I also believe you should weight this based partially on your belief and confidence that whatever particular investment will increase, partially on the weightings of the market, and partially on other factors that help you determine what a particular investment is worth. Multiple asset class investing

I struggle to find a pure example of a multiple asset index fund, but basically it is what the hedge funds do as described in money and markets, and I believe there are multi asset funds like this to use as a reference. The GTAA is close as the top 5 holdings contain REITs, Commodity index and TIPS bond fund.

Money and markets has another good article titled the five golden rules, which talks briefly about holding multiple asset classes.
* Diversify beyond the stock market by investing in various asset classes. Some people think that “diversification” means spreading your money among multiple stocks or stock market sectors. We have never believed that to be adequate, and the wholesale decline of nearly all market sectors in 2000-2002 vindicated our views.

A truly diversified portfolio should also include Treasuries, gold-related investments, other hedges against inflation, and, at the right time, other asset classes like real estate.

* Maintain a balanced portfolio. Too many investment decisions are based on just one theory about the future direction of the market. I myself have strong views about the future, but I also recognize that, ultimately, the future is not predictable.

In the next part of this series of articles we will get more in depth at creating our own portfolio that takes the concepts of value weighting as well as the concepts from multiple asset funds and starts the process of putting together our own multiple asset value weighted diversified portfolio that will periodically be rebalanced.

This series continues
part 2:Creating your own value weighted multiple asset index fund
part 3: create value weighted multiple asset index fund using etfs