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The Strengths of World-Allocation Funds Are Clear

And there are a few compelling options in this category.

William Samuel Rocco, 10/14/2008

World-allocation funds have the broadest purviews in the mutual fund universe. Only they, world-stock offerings, and world-bond funds have the leeway to scour the entire globe for investment opportunities without concern about geographic borders. World-allocation funds can--and do--make full use of the asset-class spectrum, while world-stock offerings focus on equities and world-bond funds concentrate on fixed-income securities.

This breadth has been quite helpful in 2008's terrible conditions. World-allocation funds devote around 40% of their assets to a mix of cash, short-term credits, and higher-quality intermediate-term U.S. and foreign bonds. Those asset classes have eked out tiny gains or posted limited  losses this year, while equities have plunged around the globe. Therefore, though they're down a painful 21%, world-allocation funds have lost 9 percentage points less than world-stock offerings as well as 3 to 7 percentage points less than domestic large-cap funds and 10 to 14 percentage points less than foreign large-cap offerings for the year to date through Oct. 3.

Significant Long-Term Success
This year's outperformance is certainly no fluke. World-allocation funds have comfortably outpaced world-stock offerings over the trailing three-, five-, 10-, and 15-year periods, and their returns over those periods look quite good relative to those of domestic large-cap funds and pretty good relative to those of foreign large-cap offerings. And not surprisingly, given the moderating effects of their fixed-income stakes, these funds have suffered significantly less volatility than all of those types of offerings. Further, while world-allocation funds have lost more than moderate-allocation offerings (which mainly stick to the U.S.) this year, largely because foreign stocks have suffered more than domestic ones, these funds have better long-term risk reward profiles than those offerings, as their broader geographic range has generally been helpful.

Of course, these funds won't always post superior returns. They've benefited from the facts that bonds have performed exceptionally well relative to equities over the past decade and that foreign securities have fared better than their domestic counterparts (partly due to weakness in the U.S. dollar). They will be at big disadvantage relative to world-stock, domestic large-cap, and foreign large-cap offerings whenever stocks mount strong rallies, and they will be at big disadvantage relative to moderate-allocation offerings whenever U.S. securities dominate their overseas competition. Still, there is real merit to allowing managers to invest wherever they can find attractive opportunities; these funds have proven they can deliver attractive returns with modest volatility over the very long run; and they tend to be less expensive than world-stock offerings and comparably priced with moderate-allocation funds. Thus, world-allocation funds are quite worthy of attention from risk-conscious investors who are seeking core offerings to build around as well as those who are in search of stand-alone holdings.

Look Before You Leap
Such investors do need to choose carefully, though. Roughly half of the 54 world-allocation funds opened in 2006, 2007, or earlier this year and thus are unproven. And the untested funds aren't the only ones that should be approached warily or avoided outright. Some of the more-established offerings have serious flaws and should be shunned. Above-average expenses, an uninspiring record, and some errant decision making in recent years make Evergreen Asset Allocation EAAFX a poor option, for example, while deteriorating performance and the departure of some key personnel have rendered the once-appealing UBS Global Allocation BPGLX unattractive.

Personnel issues have also lessened the previously exceptional appeal of First Eagle Global SGENX. One of the two skippers behind the fund's excellent long-term record, Charles de Vaulx, left suddenly in March 2007; other key members of the management team left that year; and the manager primarily responsible for the fund's past success, Jean-Marie Eveillard, will retire--for the second time--in March 2009. The two managers who will run the fund after Eveillard retires--Matthew McLennan and Abhay Deshpande--don't have track records as managers of open-end funds (though they do have experience running private accounts). Thus, while the conservative value strategy that has worked so well here in the past will remain in place--and there are grounds for optimism--we're not as confident about the fund as we used to be.  

We are, however, becoming increasingly confident about Thornburg Investment Income Builder TIBAX and Ivy Asset Strategy WASAX. Though it has lagged this year, the former has posted impressive overall results with a focused and distinctive approach, and other Thornburg offerings have done the same. Ivy Asset Strategy has been a so-so performer in 2008, and it isn't for the faint of heart, because it follows a bold top-down strategy and has been much more volatile than most of its peers. But it has posted strong long-term returns and has a really seasoned management team.

Finally, there are two world-allocation funds that boast a broad array of strengths and that we have long believed in: American Funds Capital Income Builder CAIBX and BlackRock Global Allocation MDLOX. The former enjoys an exceptionally low expense ratio, a superior yield, and one of the deepest and most experienced management teams around. Moreover, it employs a straightforward strategy that is inherently sound, and it has delivered fetching risk-adjusted results. BlackRock Global Allocation's many attractions begin with long-serving skipper Dennis Stattman, his sizable support team and their contrarian but not overly daring approach. A first-rate risk/reward profile and a modest expense ratio round out its appeal.

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