The benefits of balance: funds that play both stocks and bonds might shield you in tough times - Mutual Fund News

Black Enterprise, Sept, 1997 by James A. Anderson

We wouldn't be surprised if earlier this year a lot of Dow watchers were getting a bit seasick. One day the market was reaching a new high, and the next day it seemed to recoil as quickly as it had risen. On top of that kind of volatility, the buzz was less than glowingly optimistic in the investing world, centering on whether stocks were overvalued or on if and when the Federal Reserve would raise rates and put a halt to the stock market's run.

Where do you put your money in such an environment? The mutual fund industry's answer for jittery investors like yourself has been a type of hybrid investment called either balanced funds or asset allocation funds. The two breeds are similar: they invest in both stocks and bonds, offering the capital appreciation of the former and the secure yield of the latter. The underlying logic behind the hybrids is simple: when stocks are hot, the funds will be able to tap the trend. When stocks are shaky, investors will probably seek shelter in bonds. That's when the bond portfolio of a balanced or asset allocation fund will steady things.

There are minor differences, though. Balanced funds typically mandate that portfolio managers keep a set mix, say 60% of their overall investment in the stock market and 40% in bonds. Asset allocation funds tend to be looser, allowing managers to roam from category to category.

Typically, a hybrid fund under good management, while not quite keeping up with the high flight of the stock market, will at least beat out indices for the bond market. In 1996, the group average return was 13.4%, almost 10 points behind the S&P 500 but still nearly 10 points above the Lehman Aggregate Bond Index for the year. In 1995, hybrids turned in a respectable 24.31% average return. Although that trailed the S&P 500 by 13 points, it exceeded the Lehman bond index by 6 percentage points.

All the same, despite the calming reassurance of names like "balanced" and "asset allocation," there is some risk, especially as seen in years like 1994, when both stocks and bonds turned in weak performances. Some hybrid funds, like Fidelity's Asset Manager, got clobbered, suffering a 6.6% year, compared with a 1.32% gain for the S&P 500, and a 2.92% drop in the Lehman average, the group fell 3.05% that year.

That warning aside, there are a number of good hybrid funds to choose from, many with ample ability to keep up with and even surpass the stock market. In hunting for funds, we turned to Morningstar, the Chicago mutual fund rating group. Within their Principia database, BE tracked funds that turned in above-average performances over the last five years, a good long-term measure of management's skills. We looked for funds that didn't charge load fees when buying in or cashing out of the fund. Our criteria included an above-average showing in 1994, a year we feel was a very good test of a portfolio manager's ability to preserve investors' capital during extremely difficult times. Finally, we looked at the funds' alpha, a statistic designed to show how much risk management has taken on to boost returns. The alpha ratio measures how much a fund's portfolio fluctuates, while comparing that to the gain investors stand to pocket. An alpha above 0 means investors were rewarded handsomely for the risks they incurred by investing in the fund; far below 0 means risks incurred didn't always pay off in solid gains. For our purposes, we looked for a fund's alpha to be close to 0, a sign that a balanced fund manager's portfolio was doing its job keeping risks in check.

We came up with four good picks. Third Avenue Value (800-443-1021) led the group with a five-year 18.66% average annual return. The fund, which currently is stock-heavy with 60% of its portfolio in the market, managed to keep its 1994 loss down to a mere 1.46%, and tallied an impressive 31.73% gain in 1995. Likewise, the Fidelity Puritan Fund (800-544-8888) has about a 60% slice of its portfolio invested in stocks. Its five-year average annual return is 15.4%. In 1994, the fund actually registered a 1.78% gain. Founders Balanced (800-525-2440), another stock-heavy portfolio, has averaged 15.4% in total return over the last five years. Finally, we chose a fund with a relatively big weighting in bonds to round off our group. Dodge & Cox Balanced (800-621-3979), with a 14.49% average annual return over the last half-decade, has held its own within the hybrid group, and can boast a 2% gain under 1994's tough conditions.