Dion Money Management Blog   Money Management for Retirees and Their Families

Year to date, shares of the United States Natural Gas ETF (UNG) have fallen more than 50%, while shares of First Trust ISE-Revere Natural Gas (FCG) have jumped more than 58%. The important difference in performance between these two funds can be credited to structure and the ongoing drama unfolding in the futures markets.

The affect of futures markets regulation on funds like UNG has yet to be fully realized, but early indications show that there will be a profound impact on futures-based funds. As the Commodities Futures Trading Commission seeks to dampen the impact that exchange-traded products have on the commodities they track, a wave of mercy killings, restructurings and halts in share creation is likely to continue.

Drama isn’t good in the world of passively indexed products. Most ETFs are launched with an objective and a means of execution. In the case of futures-based products like UNG, it is to track the price of oil synthetically through natural gas futures contracts. FCG, on the other hand, tracks natural gas companies through a basket of equities.

Natural gas isn’t the only place where this occurs. Investors looking to gain exposure to agriculture can choose PowerShares DB Agriculture (DBA) or Market Vectors Agribusiness ETF (MOO). DBA tracks the futures contracts of commodities like corn, wheat sugar and soybeans. MOO, on the other hand, tracks agriculture companies like Syngenta (SYT) and Monsanto (MON). Year to date, MOO is up 45% while DBA is down 0.34%.

Historically, the argument made for futures-based commodity funds like UNG and MOO has been that baskets of futures are more of a “pure play” on commodity prices than baskets of equities. While the spot prices of commodities impact both futures markets and companies that deal with the commodities, the connection is stronger when you look at the futures markets.

Commodities-driven firms, like Monsanto, have fixed costs, so the price of a company’s stock can vary significantly from the price of the raw materials that it uses. These unknowns have been enough, historically, for some ETF investors to choose futures-based funds to gain exposure to the commodities markets.

Now, however, the uncertainty surrounding futures-based ETFs has impacted the advantages of their structure. A halt in share creation over the summer sent UNG’s premium skyrocketing more than 16% — a figure that has returned back to near-normal since the resumption of creation.

On June 16, I recommended that investors stay away from UNG and instead consider FCG. (See A Natural-Gas ETF With Fewer Headaches. ) This recommendation was in light of UNG’s contango issues. Share creation in UNG was then halted on July 7, compounding UNG’s problems. (See Natural Gas ETF ‘Taxed’ by Delay.) Since June 16, FCG has advanced 31%, while UNG fell nearly 34%.

PowerShares DB Commodity (DBC) has faced its own challenges. Along with that of DBA, DBC’s portfolio was recently restructured to stay within position limits proposed by the CFTC. While investors suspect that definitive regulation will arrive soon from the CFTC, ETF managers are keeping ahead of the curve by restructuring their portfolios to stay within limits.

All of this restructuring and creation-halting has had an impact on the performance of these futures-based products and the confidence of investors who utilize them to track commodities. There was no growth in UNG’s assets last month, while FCG had a net cash flow of $162 million.

New ETF issuer Jefferies is also trying to capitalize on the uncertainty surrounding futures-based commodity funds. In late September, Jefferies launched the CRB Global Commodity Equity Index Fund (CRBQ), which tracks stocks instead of futures. Next up for Jefferies will be natural gas equity and wildcatter ETF options. (See New Commodity ETF Skirts Limits.)

The halt of share creation in iPath Dow Jones Platinum ETN (PGM) last Friday may be the latest chapter in the futures-based fund saga, but it won’t be the last. (See Platinum Futures Fund Latest Casualty.) Exchange-traded products have offered investors unprecedented access to futures markets. Now we will see if this access can last.

The size and scope of ETFs is growing rapidly, as the adaptable funds take aim at an even broader audience. Among the top most-active symbols in the market today are ETFs like the Financial Select SPDR (XLF), SPDR Trust (SPY) and iShares MSCI Emerging Markets Index (EEM), evidence that these funds have taken more than a foothold.

Originally touted as “mutual fund alternatives,” it has now become clear that ETFs stand on their own and have aim beyond the mutual fund industry. The success of individual country funds like Market Vectors Russia (RSX) and fixed income products like iShares iBoxx $ Invest Grade Corp Bond (LQD), illustrate the range of the ETF product line.

While some funds, like the Vanguard Value ETF (VTV) and the iShares Russell 3000 Value Index (IWW), don’t seem like a far shot from their mutual fund peers, commodities and bond offerings seem to be aiming at strategies that mutual funds can’t.

Due to their structure, ETFs can provide daily trading strategies, like Direxion’s Daily Financial Bull (FAS), to sophisticated investors, while offering physically backed gold funds, like SPDR Gold Shares (GLD), that can be traded intraday by a broader audience.

Since the funds are seeded by market participants, they have continued to debut on stock exchanges across the globe, even as equity IPOs remain lethargic. A recent article in Barron’s realistically notes that the 40% annual asset-growth rate of ETFs over the past 10 years will likely slow to around 20% to 25% over the next three to five years.

Tax efficiency and transparency are among the reasons that investors have flocked to passive exchange-traded products. As investors become increasingly wary of hedge fund managers, these passively indexed products will become even more appealing.

The bread and butter of the ETF industry may be sector plays, but managers would like to reach out to a broader audience. The debut of life-cycle ETFs, fund of fund ETFs and active ETFs are squarely aimed at the longer-term investor.

A two-fold question remains: Will audiences be ready for the new fleet of funds, and will popular existing funds become too big for their britches?

The anemic interest in the new actively managed funds seems to be a sign that it will take time for these funds to catch on. The Dent Tactical ETF (DENT), a recently launched active fund, has an average daily trading volume of less than 7,000 shares. Investors who are turning to ETFs out of distrust for active managers may find active ETFs hard to swallow.

Concerns over size should not be discounted. New regulation from the Commodities Futures Trading Commission has sent ETFs like United States Natural Gas (UNG) and PowerShares DB Commodity (DBC) scurrying to stay within position limits. As these funds grow ever larger, there may be further limitations for futures-based commodity ETFs.

Despite the setbacks that have challenged the relatively new industry, it seems as though we are directly situated in an ETF boom. As ETFs continue to grow, and attempt to be everything to every investor, the evolution will be remarkable to watch.

Disclaimer

The iPath Dow Jones Platinum ETN(PGM) is the latest exchange traded casualty, as ETF issuers struggle to keep ahead of upcoming futures regulation.

The futures-based platinum fund, which has just $100 million in assets, has halted creation of new shares due to anticipated position limits.

PGM’s creation halt follows in the footsteps of new “accountability” limits set by the New York Mercantile Exchange. When it comes to platinum, “accountability” limits are tripped at a lower threshold than other commodities. Currently, the limit is set at 1,500 net futures positions, approximately the same size as PGM’s assets.

PGM will now enter into the same precarious territory as funds like United States Natural Gas (UNG), iShares S&P GSCI Commodity Indexed Trust(CSG), iPath Natural Gas(GAZ) and PowerShares DB Crude Oil Double Long(DXO), as it halts creation to stay ahead of regulation.

Halting creation isn’t the only way to stay ahead of the regulatory curve. UNG has begun to restructure its underlying methodology, exchanging to-be regulated futures contracts for other investments, like swaps. PowerShares recently also restructured shares of its Deutsche Bank(DB) indexed DB Agriculture (DBA) and DB Commodity(DBC) funds.

During the DBC restructuring process, index provider Deutsche Bank took the unusual step of exchanging New York Mercantile-traded futures contracts for some holdings in Brent Oil Contracts, which trade abroad.

The willingness of these managers to restructure their portfolios suggests that when it comes to commodities ETFs – there’s a will and a way.

The case of DXO did not have as neat of a result. The popular leveraged oil fund decided to redeem shares of the fund for value, euthanizing the fund before it could be killed off by regulation.

Whether ETFs are eventually restructured or closed , the halt in share creation can negatively impact investors. ETFs are designed to track an underlying net asset value, and a halt in the creation/redemption process can dislodge a fund’s price from its worth. Investors end up paying premiums to buy into a strategy that others have bought at cost.

The resumption of creation for UNG’s shares has helped to put the fund back in line. UNG’s premium, which crept towards 20% at the height of its creation halt, has returned to a less than 5% premium to NAV. This fund has been buoyed by natural gas prices, but it is easy to see how a dramatic drop in premium during an inconvenient time would have disastrous results.

Definitive regulation on futures limitations is expected by the end of the month. ETF investors need an answer, and the uncertainty surrounding futures-based products needs to end. ETF issuers should remain committed to transparency when listing their holdings. If futures are replaced by swaps, disclosure should highlight inherent risks.

Investors who want exposure to the price metals like gold, silver and platinum without derivative exposure should check out physically-backed commodity funds like SPDR Gold Shares(GLD), iShares Comex Gold(IAU), ETF Securities Gold Trust(SGOL), iShares Silver(SLV) and ETF Securities Silver Trust(SIVR) (SIVR).

Abroad, ETF Securities has launched similar physically-backed platinum and palladium funds. The issuer filed for similar funds in the U.S. earlier this year, but has yet to gain approval and launch.

Disclaimer

The iPath Dow Jones Platinum ETN(PGM) is the latest exchange traded casualty, as ETF issuers struggle to keep ahead of upcoming futures regulation.

The futures-based platinum fund, which has just $100 million in assets, has halted creation of new shares due to anticipated position limits.

PGM’s creation halt follows in the footsteps of new “accountability” limits set by the New York Mercantile Exchange. When it comes to platinum, “accountability” limits are tripped at a lower threshold than other commodities. Currently, the limit is set at 1,500 net futures positions, approximately the same size as PGM’s assets.

PGM will now enter into the same precarious territory as funds like United States Natural Gas (UNG), iShares S&P GSCI Commodity Indexed Trust(CSG), iPath Natural Gas(GAZ) and PowerShares DB Crude Oil Double Long(DXO), as it halts creation to stay ahead of regulation.

Halting creation isn’t the only way to stay ahead of the regulatory curve. UNG has begun to restructure its underlying methodology, exchanging to-be regulated futures contracts for other investments, like swaps. PowerShares recently also restructured shares of its Deutsche Bank(DB) indexed DB Agriculture (DBA) and DB Commodity(DBC) funds.

During the DBC restructuring process, index provider Deutsche Bank took the unusual step of exchanging New York Mercantile-traded futures contracts for some holdings in Brent Oil Contracts, which trade abroad.

The willingness of these managers to restructure their portfolios suggests that when it comes to commodities ETFs – there’s a will and a way.

The case of DXO did not have as neat of a result. The popular leveraged oil fund decided to redeem shares of the fund for value, euthanizing the fund before it could be killed off by regulation.

Whether ETFs are eventually restructured or closed , the halt in share creation can negatively impact investors. ETFs are designed to track an underlying net asset value, and a halt in the creation/redemption process can dislodge a fund’s price from its worth. Investors end up paying premiums to buy into a strategy that others have bought at cost.

The resumption of creation for UNG’s shares has helped to put the fund back in line. UNG’s premium, which crept towards 20% at the height of its creation halt, has returned to a less than 5% premium to NAV. This fund has been buoyed by natural gas prices, but it is easy to see how a dramatic drop in premium during an inconvenient time would have disastrous results.

Definitive regulation on futures limitations is expected by the end of the month. ETF investors need an answer, and the uncertainty surrounding futures-based products needs to end. ETF issuers should remain committed to transparency when listing their holdings. If futures are replaced by swaps, disclosure should highlight inherent risks.

Investors who want exposure to the price metals like gold, silver and platinum without derivative exposure should check out physically-backed commodity funds like SPDR Gold Shares(GLD), iShares Comex Gold(IAU), ETF Securities Gold Trust(SGOL), iShares Silver(SLV) and ETF Securities Silver Trust(SIVR) (SIVR).

Abroad, ETF Securities has launched similar physically-backed platinum and palladium funds. The issuer filed for similar funds in the U.S. earlier this year, but has yet to gain approval and launch.

Disclaimer

Don Dion posts his current insights on the stock, bond, commodity and currency markets in his RealMoney blog, anticipating which ETFs will be in play next. Among his blogs this week were the following, in which he wrote about developments in energy ETFs, Europe and Korea ETFs, and improving relations between Turkey and Armenia.

Breakout for Energy ETFs?
Posted 10/16/2009 2:56 p.m. EDT
Gasoline inventories declined by 5.2 million barrels last week, while analysts had expected an increase.

Crude oil inventories increased by 0.4 million barrels, but it was overshadowed by the big decline in gasoline and a smaller decline in distillates, which includes heating oil.

Refinery utilization is down for maintenance and that could mean a few more weeks of inventory declines. Nevertheless, gasoline inventory is 15.4 million barrels above 2008 levels at this time, distillates are 48.6 million barrels above last year’s levels, and crude oil inventories are 29.6 million barrels higher.

Equity investors followed the pop in oil yesterday by pushing up the price of energy ETFs. Energy Select SPDR(XLE) gained 2% to close at its highest level since October 2008.

Shares of refiner Tesoro(TSO) gained 8.6%, and Valero(VLO) advanced 7.1%.

iShares Dow Jones U.S. Oil & Gas Exploration & Production(IEO) is the ETF with the largest exposure to TSO at 0.83%; it gained 1.9% yesterday. IEO also has the largest exposure to VLO, at 3.02%.

We’ve seen natural gas, crude oil and now gasoline jump and plunge based on large, unexpected swings in inventories. It is partially due to economic data that provides a mixed picture of the economy, along with huge amounts of liquidity created by the Federal Reserve.

A lack of transparency in the economy plus a lot of money to bet on the analysts’ hunches leads to high volatility. Unless a trend develops that pushes oil out of the $60 to $75 dollar range, use the drops to buy and the surges to sell.

Boon for Europe, Korea ETFs
Posted 10/15/2009 12:43 p.m. EDT
The trade agreement struck this week between South Korea and the European Union is of major significance and could have positive implications for international exchange-traded funds that track the two economies.

This week’s agreement, which still needs the approval of lawmakers, would be the second-largest in history. Only the 1994 North American Free Trade Agreement among the U.S., Canada and Mexico is bigger.

Funds to pay attention to include iShares MSCI South Korea Index Fund(EWY), iShares S&P Global Healthcare Sector Index(IXJ), PowerShares FTSE RAFI Europe Portfolio(PEF) and Vanguard European ETF(VGK).

The new deal between South Korea and the EU would get rid of tariffs and other protectionist barriers, making 99% of the trade between the two regions duty-free. According to this Bloomberg report, European companies from the health care, consumer and financial sectors are expected to benefit most.

One group working to undermine the agreement is the European car manufacturers. The companies are wary of the competitive advantage South Korea would gain.

South Korea also expects to gain from the agreement. According to South Korean analysts cited by Bloomberg, the pact is expected to boost the nation’s GDP by more than 3% and increase employment by more than 3.5%.

Turkey and Armenia Establish Relations
Posted 10/12/2009 3:46 p.m. EDT
One ETF I have followed closely in my blog is the iShares MSCI Turkey Investable Market Index (TUR). This fund, designed to follow a basket of companies that represent the broad Turkish market, has performed fantastically in 2009. In three months, the TUR has popped 41%. Year-to-date for the period ending Oct. 9, the fund is up over 99%.

For nearly a century, the relationship between Turkey and Armenia has been hostile, stemming from the mass killings of Armenians under the Ottoman Empire in 1915. The dispute has since resulted in closed borders between the two nations, essentially cutting the Middle East off from the rest of Europe.

Recently, however, relations between Turkey and Armenia have appeared to thaw. In Zurich late last week, the leaders of the two nations met to sign a set of diplomatic protocols. In the end, they agreed to open their borders to one another.

On Oct. 14, the real effect of this agreement will be felt when Armenian president Serzh Sargsyan enters Turkey to watch a World Cup qualifier match, pitting his nation’s team against Turkey’s. It will mark the first time an Armenian leader has entered Turkey in a decade.

The TUR has already responded to the great news with a nearly 2% jump in early trading on Monday.

Disclaimer

Trying to time purchases or sales of financials like Goldman Sachs(GS) or Citigroup(C) over the last year could have resulted in devastating losses.

Likewise, emerging-market ETFs like Market Vectors Russia(RSX) and iShares FTSE/Xinhua China 25 Index(FXI) have vacillated dramatically during the economic slump and recovery.

Now, more than ever, it is increasingly important to understand the difference between tactical and market timing. While performance chasing and market timing may be tempting, the difficulty of forecasting broad short-term market movements makes that strategy unworkable: Numerous studies have shown that market-timing investors are far more likely to miss out on market gains than they are to avoid market losses.

Tactical allocation, on the other hand, involves making occasional modest tweaks to strategic allocations to adjust for realities and opportunities in the capital markets. For example, stocks historically have outperformed bonds when the economy shows signs of picking up steam, because an accelerating economy makes it easier for corporations to generate profits and cash flow.

Bonds, on the other hand, often suffer when an economy strengthens, because the expanding economy generates inflationary pressures and triggers higher interest rates. Given that backdrop, a tactical investor might want to boost her stock allocation slightly and decrease her bond holdings commensurately.

Tactical allocation assumes that market cycles present opportunities for investors who are observant and disciplined enough to capitalize upon them. The extremely divergent performance of small- and large-cap stocks led to massive valuation discrepancies at the end of the 1990s.

Investors who believed that small-value stocks eventually would come back into favor — those who had discipline to increase their small-value stakes following a half-decade of subpar performance — were amply rewarded during the subsequent six years, as stock returns reverted to their long-term averages.

Many investors in the late 1990s probably boosted their small-cap holdings long before the market turned in their favor, and they had to wait for months or years before their tactical allocation decision paid off.

That kind of patience represents another key distinction between tactical allocation and market timing: Whereas market timers attempt to buy at a market low and sell at a peak, investors using tactical allocation simply try to increase exposure to assets that they believe have a higher probability of superior performance going forward.

Such investors recognize that the market might take a long time to come around to their point of view. For that reason, investors making tactical allocation decisions typically deviate only modestly from their long-term strategic allocation targets. That allows them to maintain exposure to any growth that occurs in other parts of the market.

Indeed, tactical allocation involves acknowledging and planning for the possibility that allocation decisions could be flat-out wrong. The best investors, from Warren Buffett to Peter Lynch to Legg Mason Value’s Bill Miller, are united in their humility: They know they won’t get every investment decision right — but they also know that they don’t need to. That approach is very different from market timers’ all-or-nothing results.

Active investors may want to tweak their asset allocations based on their own takes on the market. Such investors should be cautious, however: Frequent trading can open the door to emotional investment decisions and higher trading-related costs, which typically result in lower investment returns.

. Annual rebalancing might offer an opportunity to take stock of the prospects for various asset classes and to boost exposure modestly to those that look poised for superior performance.

Remember to keep any tactical shifts small, no matter how strong your convictions are that a particular investment is ripe for a rally. Say your domestic stock portfolio currently holds 70% in large caps and 30% in small caps, and you decide to boost your exposure to blue-chips. You might want to sell at most a third of your small-cap stake and invest the proceeds in a fund that holds the market’s largest stocks, bringing your large- and small-cap allocations to 80% and 20%, respectively. Resist the urge to make more-dramatic shifts.

As the late British economist John Maynard Keynes once famously said, “The market can stay irrational longer than you can stay solvent.”

Disclaimer

The Dow Jones Industrial Average completed its roundtrip to the 10,000 level this week after posting its largest one-day gain since August 21. The rally that began in March has been swifter and steadier than most would have expected given the threats to the banking industry and the credit markets. Although valuation becomes trickier at these heights, the economy continues to make steady progress in manufacturing, sales, and employment.

This week both the New York and Philadelphia manufacturing surveys reported increases in overall activity. This was the third straight month that these surveys indicated headline growth. The details of the New York report were particularly strong, including its employment index. The question remains the extent to which activity is driven by the rebuilding of depleted inventories or sustainable demand. Even inventory replenishment, however, can be an essential component of aggregate demand at key cyclical turning points such as this.

Although employment continues to contract, the pace is slowing, exhibiting a fading of weakness, so to speak. The four-week average of new unemployment claims stands at approximately 532,000, which is down nearly seven percent from one month prior. Unfortunately, this means that unemployment will continue to rise in the near to immediate term.

But as we have seen so far this year, rising unemployment does not necessarily impede the ability of stocks to advance. In fact, during the previous five recessions, the stock market appreciated 29 percent on average before unemployment peaked, according to UBS Global Equity Research. Moreover, the advance has typically continued over the following six months, recording another 4.6 percent gain on average. The tendency for employment to lag in spite of economic stability—a so-called jobless recovery—is a relatively new phenomenon, occurring in the past two recessions.

A primary force behind the stock market’s resurgence has been the improving picture of corporate earnings. More than 70 percent of companies reporting results thus far have beaten their consensus estimates. Although year-over-year revenue comparisons are down, there is sequential growth from last quarter. Sectors with the biggest improvements over the past month include financials, materials, and technology. Tech companies are reporting improvements from industrial demand, such as companies exposed to the automotive sector, which is why I continue to advocate a small overweight to Fidelity Select Automotive (FSAVX).

The rise of Market Vectors Russia ETF (RSX) has been swift, but the move is likely unsustainable, as this ETF is tied heavily to oil prices. As Exxon Mobil (XOM) and Chevron(CVX) advance in the U.S., Russia-based Lukoil (LKOD.LI) and OAO Gazprom (GAZP.RM) have helped to advance RSX more than 140% year to date.

RSX tracks 38 firms domiciled in Russia that have an average daily trading volume of at least $1 million and market cap of at least $150 million. The majority of components, more than 88%, are considered “large cap,” helping to contribute to the underlying liquidity of the fund. The expense ratio, 0.62%, is reasonable for a fund of this scope.

The driving force behind RSX’ performance has been the fund’s concentration in commodities. The top-weighted sector in the fund, comprising nearly 42% of assets, is oil. The second-largest sector represented is iron/steel, with 18.5%. Other top sectors include telecommunications, finance and energy, with 14%, 10.4% and 5.5% allocations, respectively.

A fall in global demand for oil and gas during the worst of the global economic recession caused Russia to dip more than expected. In 2008, the fund dropped more than 73% as oil prices fell. Aggressive rate cuts and surging oil demand have helped Russia recover in 2009, and RSX is up 98% for the one-year period ending Oct. 15.

RSX, like other cap-weighted emerging markets ETFs, reflects political and economic pressures inherent in these markets. More than 50% of iShares MSCI Brazil (EWZ) and 34% of WisdomTree India Earnings (EPI) are allocated toward energy and materials. When compiling a portfolio of liquid, emerging market companies, investors will often see energy and materials rise to the top.

This trend could be reversing as ETF issuers compete to launch small-cap emerging markets portfolios. The Market Vectors Brazil Small-Cap Index (BRF) is weighted toward consumer discretionary and financials, while Claymore/AlphaShares China Small-Cap Index ETF (HAO) is weighted toward industrials and information technology.

Emerging markets ETFs are a good way to diversify a broader portfolio, but investors should consider several key factors before adding RSX. Since the fund is essentially an energy play, it is important to examine existing energy exposure before doubling up. Because of the potential for volatility, this is a fund that should be bought and watched, not bought and forgotten.

The stark difference in RSX’ 2008 and 2009 performances should drive home the volatile nature of this fund. How long can the upswing continue? It will depend largely on global demand for oil, as the firms in this portfolio battle both internal and external pressures to deliver.

David Swensen has made a name for himself as the head of Yale University’s $16 billion-dollar endowment.

While his successful investing style involves holding assets that have traditionally been out of reach for the average investor, this has not stopped them from trying to mimic it. In fact, his method has become so well known it is now referred to simply as the “Yale Model.”

Swensen, who received his BA and BS from the University of Wisconsin in 1975, wrote his dissertation for his PhD at Yale’s school of Economics on the valuation of corporate bonds. The dissertation land a job on Wall Street with Salomon Brothers where he had gathered data for a team.

Swensen made Wall Street history in 1981 with Salomon by structuring the first-ever swap transaction. That led Lehman Brothers to hire him the next year to run the firm’s swap group.

At Lehman, he was approached by Yale which was interested in hiring him to manage the university’s endowment then valued at $1 billion. Although he had no prior experience managing an endowment and the new position would come with a big pay cut, he took the position and has remained there since.

In his 24 years at the helm he has returned average annual gains of 16.3%. This successful record was tainted recently when, in the midst of the worst of the global economic recession, the endowment reportedly lost nearly 25% of its value. This was largely due to its heavy exposure to energy and real estate.

Since then, Swensen and his team have been working diligently to regain the value. Today, even with the downturn, the Yale endowment is valued at over $16 billion and remains second only to Harvard.

Swensen’s success running the Yale endowment can be attributed to his bold investing style known in the financial world as the “Yale Model.” Some liken the popularity of the Yale Model to that of Warren Buffett’s Value Investing approach. However, looking at the two methods, their popularity is one of the only things they have in common.

Before taking hold of the Yale endowment, the university’s assets were invested very much like the average investor portfolio: across equities and fixed income. However, with Swensen came a new school of thinking. Rather than sticking to two asset classes, the newly appointed head decided to expand further by investing in five to six different asset classes. This quality became one of the hallmarks of the Yale Model.

While stocks and bonds still have their place in the endowment, Swensen decided to add exposure to previously untapped alternative asset classes. Today, classes including private equity, real assets and foreign equity account for a large percentage of the endowment’s total holdings.

When Swensen’s investing technique first started to gain popularity, it quickly become evident that many of his favorite asset classes were out of reach for the average investor. However, with the advent of exchange traded funds, the Yale Model has become an attainable investing technique. Today, it is relatively simple for an investor’s portfolio to include the real estate, international markets and commodities exposure that earned Swensen his strong returns.

Investors looking for real estate can choose among numerous instruments including iShares Cohen & Steers Realty Majors(ICF), Vanguard REIT(VNQ) and SPDR Dow Jones REIT(RWR).

International ETFs like Market Vectors Brazil Small Cap ETF(BRF), Claymore/AlphaShares China Small Cap Index ETF(HAO) and iShares MSCI United Kingdom Index Fund(EWU) allow investors to easily gain exposure to foreign markets.

Commodities are more accessible than ever. An investor interested in futures contracts can hold instruments like PowerShares DB Commodity Index Tracking(DBC) or UNG while those interested in baskets of commodity producing companies can choose First Trust ISE-Revere Natural Gas(FCG), Jefferies-TR/J CRB Global Commodity Equity Index Fund (CRBQ) or Market Vectors RVE Hard Assets Producers ETF(HAP).

Today, Swensen’s financial influence extends beyond Yale and has gained the notice of Washington’s top officials. As a member of President Obama’s economic advisory board he has a strong voice in the future success of ours and the world’s economic recovery.

Vanguard has closed its Capital Value Fund(VCVLX) to new investors, after top holdings like Wells Fargo(WFC) and Qualcomm(QCOM) put the fund at risk for overheating.

The move to close the fund to new investors is in part to shield existing investors, Vanguard notes. The influx of more than $740 million into the fund this year could drive performance-chasing investors to trade in and out of the fund, hiking transactional fees for all. The fund has risen more than 76% year to date and tripled in size.

Vanguard’s action could be judged as a bullish indication for mutual fund investors. After the market recovered from Internet-bubble lows in 2003, many popular mutual funds were closed to new investors. The downturn in 2008 once again spurred a reopening of funds. The fact that Vanguard can afford to be selective is a good sign that flows are on the upswing.

In addition to WFC and QCOM, VCVLX’s top five holdings include Delta Air Lines(DAL), Apple(AAPL) and Bank of America(BAC). The fund, which seeks long-term return through investment in “undervalued” securities, has approximately 38% of its portfolio allocated to its top 10 holdings.

Rapidly rising mutual funds often attract performance-tracking onlookers. In an interview with The Wall Street Journal, Vanguard Chief Executive Bill McNabb noted that “despite our efforts — at both a company and an industry level — to educate investors about the perils of performance-chasing, we continue to be concerned about this behavior.”

By closing the fund to new shareholder accounts, Vanguard will provide a “cooling-off” period for VCVLX. Existing investors will continue to be allowed to invest in the fund. This cap will prevent new investors from churning over shares of VCVLX in the short term.

Performance chasing is a dangerous maneuver seen across the security spectrum. Often, investors who climb in to mutual funds or ETFs that have spiked face the tough reality of volatility on the way down. Funds that move fast are often the most volatile, and these holdings are often better satellite positions than core components.

Vanguard insists that concerns about performance-chasing, not size, presented the biggest threat to the fund. Despite the fund’s burgeoning assets, VCVLX management insists that size did not impact the fund’s investment strategy.

This sort of investor risk management, however, could soon be more of a factor for one of mutual funds’ greatest competitors: ETFs. Some of these traditionally passively managed investments have begun to actively manage “overheating” risks.

Red hot commodities markets have driven investors into ETFs like United States Natural Gas(UNG) and PowerShares DB Commodity Index Tracking(DBC) in recent months. New futures contract regulation, however, has forced both of these funds to restructure their portfolios before “overheating” and passing position limits.

Investors should consider suitability first when picking an ETF or mutual fund, and the role that the fund will play in big-picture investing. Investors chasing performance may not only be met by an abrupt downturn, but also investment limitations and regulatory uncertainty.

Disclaimer