Most Popular, Strategies

Understanding Mutual Fund Holdings and the Securities Markets

Mutual funds come in many flavors. There are stock funds, bond funds, real estate funds, and commodity funds.  There are hybrid funds which invest in combinations of the basic funds.  Many mutual funds come with impressive names, such a Magellan, so that you do not really know what investments are in the fund. With all the choices, different investment objectives, and names, it is no wonder that average investors view mutual funds as a bit mysterious.

Mutual Funds are Merely a Method of Investing

Investors choose to invest in mutual funds for the professional management they receive and economies of scale that funds provide.  While each fund has a different investment objective and holds different securities, the fund manager most times invests in the same securities that an investor could buy using a brokerage account. This is the important point behind mutual funds that people many times do not recognize fully.

Mutual funds are nothing more than a method of investing in the securities markets. Stock funds invest in large or small company stocks. Bond funds invest in US Treasuries or corporate bonds, or municipal bonds or foreign bonds, or combinations of these.

The Economic Cycle and Mutual Fund Investments

The above appears to be a very simplistic concept, but many people do not recognize the relationship between the markets and mutual funds. The markets go through cycles which normally follow the economic cycle. Stock and bond investors will normally rebalance their portfolios periodically to anticipate the changes in these cycles. However, mutual fund investors tend to be long term buy and hold investors. Once they find funds they like, they tend to hold these funds long term regardless of changing economic cycles.

Mutual Fund investors need to learn and understand the basics of investing in the various markets, and how to adjust their investments as the economic cycles change. The chart below shows the economic cycle and how classes/sectors of securities perform during each cycle.

For example, if the economy is coming out of recession, such as 2009 and 2010, this would be considered Early Expansion phase of the economic cycle. Most stocks will do well during this period, with particular focus on Technology stocks, Industrial stocks, transportation stocks, and basic Industry stocks. Then in middle expansion, stocks may continue to rise, but not at the same rate as the prior phase. In the middle expansion, commodities, such as gold, silver, and oil should do well, as in 2011. At some point, the economic cycle will turn to late expansion and that is the phase where stocks will have reached their top for this cycle.

Mutual Fund investors should be adjusting the funds they use to reflect the changes in the economic cycles. This does not mean investors have to sell all of one fund and buy all of another fund.  They should adjust their entire portfolio mix. Let’s assume and investor has a portfolio consisting of 70% stocks and 30% bonds all during the early expansion phase.  The bond funds have probably risen along with the stock funds during this phase, as they did in 2010 and 2011. With the economy now entering or being in the Middle Expansion phase in 2011, mutual fund investors should rearrange their assets so that they may be holding 60% stock funds, 20% bond funds and 20% commodity funds. Then when it appears that the economic cycle is changing into the Late Expansion phase, mutual fund investors should again rebalance their holdings to reflect that stocks have pretty much reached their top level for this cycle. Again, this does not mean pulling all money out of stock funds, but finding mutual funds that perform well during the late expansion phase, such as Consumer staples and commodity stocks.

The difficult part of analysis is an understanding that the securities markets anticipate the changes in the economic cycle by 3-9 months. So, during the middle expansion phase, when stocks are still rising quite nicely, the market may start falling and they have no idea why. It could be that the market participants are now starting to antipate the next economic phase or Late Expansion in which stocks will start dropping.

Learn the Basics of Investing based on Economic Cycles

All mutual fund investors should seek out training courses in basic investing. Local Adult Education classes many times include investment courses. Learning how to invest based on identifying various points in the economic cycle will ensure that your investments are positioned to perform well at most times. This is not to imply that such investing is easy. Following the economic cycle means moving money out of various funds at the exact point where the funds are doing so well. This movement takes discipline and an understanding the funds performing well today will underperform as the cycle changes. Leaning how to identify and stay ahead of the economic cycles will improve your investment performance and give you a new outlook on the various securities markets.


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