Some investors stunned by the stock market’s hefty losses in the first quarter have been turning to a lower-risk way to stay in the game: “balanced” mutual funds, which own stocks but also keep some portion of assets in bonds and/or money market securities at all times.
The cushion provided by income-generating securities has helped many balanced funds post positive returns this year, or hold losses to a minimum, while the average stock fund has slumped.
“People are rediscovering the virtues” of balanced funds, said Brian Mattes, spokesman for Valley Forge, Pa.-based Vanguard Group. “In the past year, many folks became painfully acquainted with what risk really means. With a balanced fund you don’t get excitement, but you can get a good night’s sleep.”
As a group, Vanguard’s lineup of balanced funds took in a net $700 million in new cash in the first quarter. By contrast, those funds saw a net $3.2 billion outflow in the first quarter of 2000, when technology stocks were zooming and many people were abandoning low-risk investments to chase what was hot.
“When the equity market was doing so well, people got spoiled, basically saying, `Why do I need a balanced fund?’ Now they know,” said Wendell Birkhofer, one of several managers for the Dodge & Cox Balanced Fund.
Through April the average balanced fund (also known as a “hybrid” fund) was down 1.7 percent this year, while the average domestic stock fund was off 6.5 percent, according to fund tracker Morningstar Inc. Of course, the major drawback of balanced funds is that when stocks surge, investors don’t get the full pop. In a booming market they can get left in the dust in terms of performance.
What’s more, investors looking for a balanced fund must shop carefully: The idea of what “balance” means in portfolio allocation among stocks, bonds and money-market (cash) securities can differ significantly among the funds.
Though balanced funds may seem at first glance like a homogenous bunch, they, too, come in a variety of flavors. Here are some of the main differences investors should keep in mind:
– Balanced funds can have very different asset mixes. Vanguard Group’s Mattes notes that Vanguard Wellington, which at nearly $23 billion in assets is the biggest as well as the oldest balanced fund, generally hews closely to a 60/40 asset mix: 60 percent stocks and 40 percent bonds, in the classic balanced tradition.
“If the managers get really wild and crazy they might bring it up to 65 percent stocks or 70 percent at most,” Mattes said.
With 36.5 percent in stocks at March 31 and about 60 percent in bonds, Vanguard Wellesley Income is almost a mirror image of Wellington. Wellesley is aimed at investors who place a premium on income.
Pax World Balanced, meanwhile, will shift the equity portion of its mix from as low as 55 percent to as high as 75 percent of assets, depending on how bullish manager Chris Brown’s outlook is.
“If it gets below 55 percent, that means we think Armageddon is probably following shortly,” he joked.
Though the cash portion of assets is often minimal at balanced funds, some portfolios, including Franklin Income and Janus Balanced, recently held hefty chunks of assets in cash.
– How balanced funds deploy their equity portion also can vary greatlyJanus Balanced is more conservative than most Janus funds, but it looks downright bold next to Dodge & Cox Balanced, which sticks to a “deep value” discipline of stock-picking.
Some balanced funds can tilt even more toward “growth” investing than Janus Balanced. Stocks in MainStay Total Return, for instance, have an average price-to-earnings ratio of 33 and a price-to-book-value ratio of 8, according to Morningstar’s analysis. Dodge & Cox Balanced, by contrast, has an average stock P/E of 19 and a P/B of 2.6. The dive in growth stocks last year left the MainStay fund with a negative total return of 4.5 percent, as its bond assets couldn’t offset the losses in stocks.
Pax World Balanced puts a “responsible investing” twist on the balanced fund concept, avoiding any securities of companies involved with weapons, tobacco, liquor or gambling, or whose environmental or employment practices it dislikes.
“It’s an extra level of screening,” Brown said.
Bolstered by strong performance in recent years, the fund had a record net cash inflow of $110 million in 2000, and so far this year it has taken in $25 million, Brown said.
As with stocks, the type of bonds balanced funds own can make a difference in performance, though perhaps less so than with differences on the equity side. Many balanced fund managers stick with high-quality bonds, mainly Treasuries or high-rated corporate issues, while others can add corporate junk bonds to the mix to try to boost returns.
Investors should check a fund’s prospectus and its latest reported holdings to get a sense of how much risk the fund can take in both stocks and bonds.
– Balanced funds may keep their asset mixes relatively steady, or may try to maximize returns through tactical switching.
“We do actively manage the mix,” said Gary Langbaum, who directs the Kemper Total Return and Scudder Balanced funds. From 1995 through the third quarter of 2000, he kept stocks at roughly 65 percent of assets in both funds. Now stocks make up about 53 percent of assets at both funds.
Of course, asset weightings in a balanced fund can change automatically with market swings, unless a fund manager intervenes to maintain the mix. That kind of intervention is considered classic in the balanced fund school: the idea of letting the market tell the manager what’s cheap and what’s expensive, rather than relying on the manager’s personal timing intuition.
STRIKING A BALANCE
Bolstered by their bond and cash components, most “balanced” mutual funds have held up better recently than the Standard & Poor’s 500 index of blue-chip stocks. But the asset mix of balanced funds can vary substantially, as this sampling shows. Allocation figures are as of March 30. Year-to-date returns are through April 30. Assets are in billions.
%% FUND STOCKS BONDS CASH 2000 RETURN YTD RETURN ASSETS
Vanguard Wellington 65.4% 34.6% 0% 10.4% 3.2% $22.9
Fidelity Puritan 62.3 35.9 1.8 7.8 0.3 20.3
Vanguard Star 61.2 38.6 0.2 11.0 1.2 8.0
Franklin Income A 42.5 41.6 15.9 20.6 2.2 7.3
Vanguard Wellesley Income 36.5 60.2 3.3 16.2 3.3 6.6
American Funds Balanced 60.9 31.6 7.5 15.9 4.7 6.3
Fidelity Balanced 55.0 38.9 6.1 5.3 1.8 6.3
Merrill Lynch Balanced Capital A 63.0 32.0 5.0 7.8 -2.9 5.9
Putnam: George Putnam A 57.2 39.4 3.4 9.3 1.0 5.3
Dodge & Cox Balanced 60.6 35.2 4.2 15.1 6.0 4.9
Janus Balanced 43.5 43.5 13 -2.2 -2.5 4.6
Kemper Total Return A 53.7 42.2 4.1 -2.8 -2.5 3.0
MainStay Total Return A 56.9 41.0 2.1 -4.5 -8.0 3.0
Pax World Balanced 58.1 32.0 9.9 5.7 -2.6 1.2
Scudder Balanced 53.3 44.3 2.4 -2.4 -2.5 0.5
S&P 500 index -9.1 -5.0
%%
Source: Morningstar Inc., fund companies
