What Your Retirement Portfolio Needs Now

Evolution in the global capital markets and in investment vehicles is changing how investors must construct their portfolios to get the greatest return for a successful retirement.

You need to examine the allocation of your retirement portfolio now, if you haven't already. Ensuring that you get the best return takes some rearranging from time to time, and you'll want to take advantage of investment products that are available now that can help maximize your efforts.

This past weekend, Barron's reiterated this thesis with a suggested portfolio put forth by Mohamed El-Erian from Pimco. Let's use this portfolio as a starting point for our discussion now on how to get the most return on your retirement portfolio. In case you missed it, here is what El-Erian suggested for allocations:
  • domestic equities: 15%
  • foreign developed equities: 15%
  • emerging-market equities: 12%
  • private equity
  • domestic bonds: 5%
  • foreign bonds: 9%
  • real estate: 6%
  • commodities: 11%
  • inflation protected bonds: 5%
  • infrastructure: 5%
  • special opportunities: 8%

One quick note: The percentages given in Barron's add up to only 98%. Obviously, anyone actually taking El-Erian's suggestions could allocate the 2% elsewhere, or hold it in cash or, keeping consistent with the diversification, foreign currency.

With El-Erian's suggestions, only about one-third would be in domestic equities, which would require a big shift in thinking for the typical U.S. based investor. What you may want to do here is simply capture the equities exposure and go along for the ride.

El-Erian obviously believes foreign and emerging equities will continue to outperform the domestic market. If he is correct, then just having the foreign exposure will add value for a U.S.-based investor. This line of thinking clearly makes sense as the U.S. stock market has endured an eight-year round trip to nowhere with no turnaround in sight.

For the domestic portion, one smart way to play this is to blend together large-cap and small-cap. A good proxy for domestic large-cap is the iShares Russell 1000 Index Fund ( IWB).

For small cap, the SPDR DJ Wilshire Small Cap ETF ( DSC) should work well. Based on where the current stock market cycle appears to be, 10% in IWB and 5% in DSC is prudent for now, but when the next bull market begins, I would switch those percentages around.

Looking at the foreign developed equities portion, the easy pick would be iShares MSCI EAFE ( EFA), but EFA allocates almost 20% to Japan. I would prefer to have less exposure than that, as I do not believe the country is anywhere close to getting back on the right track. The WisdomTree DEFA Fund ( DWM) delivers comparable exposure with only 9.28% in Japan. For smaller-cap exposure, the fairly new iShares MSCI EAFE Small Cap Index Fund ( SCZ) is off to a good start in this segment. Here again, I would favor larger over small for now with the same 10% to 5% split.

Allocating 12% into emerging markets means more exposure to that group than most people have. Anyone with 5% to 6% in emerging markets increasing it to 12% of holdings would mean signing up for noticeably more volatility. While that increased exposure to emerging markets might be the right weighting over the course of an entire market cycle, the next big dip in the market could be painful.

Medium-sized declines in the U.S. have often meant large declines for emerging markets. This year has been a good microcosm to see how funds react to market stresses, and over the course of 2008, the smoothest ride for a broad-based emerging-market fund came from the WisdomTree Emerging Market High Yielding Equity Fund ( DEM), regardless of your allocation amount.

The private-equity allocation is the most difficult to access. Some of the investment offerings that trade as private equity actually have stakes in the business of running private-equity funds, not the funds themselves. The vehicles that really are the pools of capital can trade away from their NAVs. I wrote about MVC Captial ( MVC) at the beginning of the year. It has a well-diversified investment mix and has been steadier than many of the other names in the space.

Individual issues are probably a better way to go if you would just use Treasuries for domestic bond exposure, and the suggested 5% doesn't leave too much room for a lot of different domestic exposures. Individual Treasuries should do the trick, but some other suggestions are noted below.

Foreign bonds have only one ETF to choose: the SPDR Lehman International Treasury Bond ETF ( BWX). BWX yields a little above 4.13%, but adding in some Aberdeen Asia Pacific Income Fund ( FAX), a closed-end fund, would enhance the yield. If you allocate 5% to BWX and 4% to FAX, that would increase the yield by 100 basis points over just holding BWX. This play would avoid any unreasonable single country bets.

With the real estate allocation, you could find any of a number of REIT ETFs, but an odd thing happened last summer during the start of the financial sector meltdown. Real estate investment trusts correlated very closely with financial stocks, and anyone with too much exposure to both was forced to endure a lot of angst. Lately I have started to research buying publicly traded farms -- yes, as in agricultural ventures -- as a proxy for real estate in a portfolio.

It's a little too early for me to recommend any stocks in this space, but here are a couple of names for you to research on your own: Australian Agricultural Company Limited ( ASAGF)), which owns 585,000 head of cattle, and Black Earth Farming ( BLERF), which is listed in Stockholm but owns farmable but as yet unfarmed land in southwest Russia.

Several others are also available with a lot of them in Asia. One prudent way to invest would be to put 3% in to two different farms that are preferably in different parts of the world to lessen the risk.

Like with emerging markets, El-Erian's suggested allocation to commodities at 11% is a high number for a lot of people. (Generally, I prefer closer to 5% in commodities.) In looking at the broad-based commodity products, three of the popular ones are iPath DJ AIG Commodity Index Total Return ( DJP)), PowerShares DB Commodity Index Tracking Fund ( DBC) and Rogers International Commodity Index Total Return ( RJI).

Given the huge run in energy lately, I would want to avoid DBC because it allocates by far the most to the energy complex at 60%. That leaves DJP and RJI, but RJI has a more diverse allocation so it would be my choice here.

Inflation-protected bonds are a great tool. The simplest exposure is with iShares Lehman TIP ETF ( TIP), and I would also include SPDR DB International Government Inflation Protected Bond ETF ( WIP). You could add the missing 2% from above into this portion of the portfolio and put 3% in TIP and 4% in WIP.

The easiest way to buy infrastructure is the iShares S&P Global Infrastructure Index Fund ( IGF), but it may not be ideal for diversification as it has correlated very closely to the S&P 500. An investor willing to consider individual stocks might want to consider a combination of SNC Lavalin ( SNCAF) from Canada and Swiss engineering firm ABB ( ABB).

The special opportunities allocation could be viewed as a place to really go for outsized returns by isolating narrow themes such as countries or big macro trends. excellent point Brazil has a lot going for it in this light. Some choices here are the iShares MSCI Brazil ( EWZ), and plenty of stocks including Petrobras ( PBR), which which stand to dramatically alter Brazil's role in the global energy market in the next decade.

Agriculture is another theme that has been going in the right direction. The Market Vectors Agribusiness ETF ( MOO) is a good proxy for this segment, and anyone who knows about agribusiness knows about stocks like Potash ( POT) and Mosaic ( MOS). These stocks should continue to perform well.

The special opportunities portion of the portfolio will require active participation on the investor's part. These things go up a lot, and although the moves seem to be fundamentally justified, they often turn around very quickly. Investors in these sorts of themes should be willing to increase and decrease exposure with any dramatic price swings.

Any sort of portfolio has strengths and weaknesses. The drawback to the portfolio suggested by El-Erian is that very little can be added from country selection, sector weightings, stock picking or increasing dividends. The advantages include a likelihood of below-market volatility, and a very good chance no matter the market condition that something will always be doing well.

Remember too that allocations should be monitored constantly and changes made whenever circumstances dictate.

At the time of publication, Nusbaum was long IGF, WIP, TIP, BWX, FAX and MVC in client holdings, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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