For several weeks I’ve been looking to buy a horse. Yesterday I found one that was spectacular. It was a big, dark colored foxtrotter mare. She had a long mane and tail and would have looked right at home at a jousting tournament with an armored knight on her back. She’s had lots of training and work and responded to the slightest cue. Giving her the command to “whoa” and just the slightest lift of the reins was enough to bring her to an instantaneous dead stop. The price was much lower than I expected. I really wanted that horse.

Instead, I ended up paying more for an older, smaller horse that wasn’t nearly as pretty.

I needed a horse that anyone would feel comfortable riding, from a five-year-old child to a considerably older grandma. The big foxtotter would have been great for my athletic sons or my fearless wife, but a little intimidating for someone who had never been on a horse. The horse I purchased is completely calm. With dogs, other horses and people running around her, she paid no attention and focused all her attention on her rider. She might not be as beautiful, but she also isn’t the least intimidating.

Many investment purchases are similar. The glitzy, high performance fund is not always the right one to buy. Let me give an example. One of my favorite exchange-traded funds (ETFs) is iShares Latin America (ILF). It is the black line on the chart below.

Notice that over the past three years, this fund has gained more than 190%!. I’m sure we all wish we had that kind of gain over that period. In spite of that great return, I would not advise my retired parents to invest in this fund because it has a high level of volatility. Thos big gains are accompanied by some fairly significant downturns. For example, an investor who bought this fund in May 2006 would have seen his account decline by about 25% in the following month.

The blue line is another fund I like called Fairholme Fund (FAIRX). In contrast, this fund has gained just 46% over the same period. That’s still a great annualized return, but the volatility is much less. This is a fund that I have advised my parents to purchase. The gold line is the Nasdaq and it is included just for comparison. Notice that FAIRX has outperformed the Nasdaq over the past three years with lower volatility.

Now let’s get back to the horse analogy. If I’ve got a dozen older, calm horses in the barn that anyone can ride without fear, then perhaps I can take a chance and buy the spirited, spectacular foxtrotter. If I’ve only got room for two horses and the people that ride them most are a couple of elderly ladies with osteoporosis then I have no business owning that type of horse. Under the right conditions I would not hesitate to buy ILF for my own portfolio. But I would not put the majority of my assets in that fund.

This week the major indices continue to move mostly sideways. We’ve had about five weeks of instability so far. I expect we could see another week or two of uncertainty before stocks stage a breakout.

There is still a lot of overall weakness in the market as traders and investors wait for a move. So far this year basic materials, realty and international funds continue to be among the top sectors. Dow Jones U.S. Basic Materials Index Fund (IYM) is up 6.99%. iShares Cohen & Steers Realty Major Index Fund (ICF) is up 6.68%. The strongest international  funds are in the Far East with Malasia up 10.8%, Japan up 4.96%, and Singapore up 4.46%.

These numbers and sectors are generally indicative of a market that is in transition. During a bull market advance returns would be much higher and we would see virtually all sectors participating. I still believe that when a breakout occurs, we will see stocks advance rather than decline. But for now, we need to watch carefully and be prepared to take defensive actions if needed.
F.S.