Spring training for your portfolio

By Tim Middleton

"Waiting Game Begins for Torre and Yankees," brayed the sports section of The New York Times last week. Spring training is about to begin, and Manager Joe Torre, who's under contract for one more season with the Bronx Bombers, will be drilling his superstars on the cagiest aspect of the sport: small ball.

Included is the lowly bunt. Bunting is scorned in "Moneyball," Michael Lewis' admiring book on the Oakland Athletics' system of statistical analysis, but Oakland has never gone to the World Series since adopting it. Torre and the Yankees have been in the Series six times in the past 11 years, and few managers are as adroit in calling for this modest play when it is the surest shot at putting a runner into scoring position.

Bunting has an analogue in the investment world: making small adjustments to a portfolio to keep it in trim. Just as bunts help teams eke out runs in low-scoring games, small moves in a low-return world -- the Standard & Poor's 500 Index ($INX, news, msgs) is up little more than 7% annually over the past five years -- can push profits up meaningfully.

"Ninety percent of returns are based on asset allocation, so when one asset gets out of balance from your original allocation, it's time to re-balance," says Dana J. Hornquist, a financial adviser in Milaca, Minn.

Fortunately for mutual fund investors, it costs nothing to make adjustments as often as they are needed. Re-balancing a portfolio of stocks or exchange-traded funds generates commissions, which discourages doing it. Fund investors have no excuse for being neglectful.

Recently, I've executed several bunts in my personal portfolio. This kind of small ball doesn't produce home runs, but I have used it to keep my holdings in line with my goals, and that's my definition of a successful season.

When you should re-balance

The general rule of asset allocation is that you re-balance when positions stray significantly from your target. The definition of "significantly" is where opinions differ. The rule of thumb is 3% to 5%, but that rule is meaningless when the positions you're looking at are small.

My allocation to commercial real estate, for example, is 5% of total assets. If I waited until that grew to 10%, I would be dangerously far from my target. Considering that the average real estate mutual fund has gone up 25.3% annually in the five years that ended Feb. 13, according to Morningstar, that category could have shot up to 15% of my nest egg.

So when I'm reviewing my smaller positions, I look instead at how much they have gained. When the real estate fund in my retirement portfolio spurted 20% between last August and last month, I sold enough shares to bring it from 6% of total assets back to 5%.

Doing so has certainly not increased my portfolio returns in the ensuing several weeks. Real estate is absolutely on fire. In one week in February, that 5% position delivered more than 20% of all the paper gains I recorded in the period. At this rate, I could be re-balancing again in just a few months, even though that could rob me of still further gains down the road.

Using a decline as a buying opportunity

Am I stupid? Well, things don't always go up. Between Dec. 14 and Jan. 11, my natural-resources fund plunged nearly 14%. I pay just as much attention to my losers as my winners. It seemed to me that this correction was a buying opportunity.

Energy accounts for about 9.3% of the S&P 500 Index, but for reasons I've discussed in previous articles, I want more exposure than that. I had boosted it to more than 12% of my assets, but the December-January correction brought it down. I brought it back up.

Since then, that position has advanced in price more than 11%. That's a bit more than the real estate fund has risen in the same period, but that is pure chance. I wasn't market-timing; I was restoring order. One important consideration in building a portfolio is balancing risks against each other. Energy and real estate play different roles in offsetting risk elsewhere among my holdings.

Portfolio re-balancing is attractive from the point of view of a finance professor because it implies selling high and buying low. For ordinary mortals, however, it can take some willpower. Sometimes assets can continue to rise or decline over long periods -- even decades.

A case in point is gold. It went down in a more-or-less straight line between 1980 and 2001. Despite that, Steve Leuthold, a renowned asset allocator and manager of Leuthold Core Investment (LCORX), has long kept 2% to 3% of his personal assets in the form of gold bullion. He told me recently that the last lot he purchased was for $275 an ounce, which was the price early in 2001. The current price is around $666.

A tactical bunt on international funds

One other adjustment I made recently was selling enough of my international stock funds to bring their share of my portfolio down to 25% of total assets, from 27%. This move was a bunt because it was purely tactical. A bolder action would have represented a strategic shift.

I happen to be studying the role of foreign investments in my portfolio right now, with an eye on making such a strategic move. One argument in favor of foreign stocks is that they trade in foreign currencies. Everybody knows the dollar is under pressure because of our outsize trade deficit.

But is it really? Looking year over year, the dollar hasn't declined against the euro for three years. Against the British pound, it's down only slightly. The greenback will buy as many yen now as it did in February 2003.

It's possible that foreign equities are coasting on their reputation. Or perhaps the dollar is ready for a sudden, huge plunge in value. My research has only begun, but depending on what conclusion it leads me to, I could be slashing foreign stock funds to 20% of assets or less. I've already cut it back from 30%, mostly by selling down the riskiest group, my emerging-markets equity fund, after it spurted an average of more than 30% a year in the five years ending Jan. 31.

Baseball being baseball, statistics are kept on bunting, and according to David H. Annis at SportsQuant.com, it succeeds in helping to win a game only about a quarter of the time.

So in baseball, calling for the bunt is an art. In portfolio management, it's a bit more scientific. Some of what happens on the baseball diamond is the result of luck. But securities' prices have a long-documented tendency to return to their middle ground.

Selling above and buying below that mean is a lot easier than asking Alex Rodriguez to knock one down at the plate just so Derek Jeter can get to second base.

At the time of publication, Tim Middleton did not own any securities mentioned in this article.