Target-date funds have grabbed the spotlight (and assets), but this screen can root out allocation funds upon which you can rely.
This article originally appeared in the April/May 2012 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
Allocation funds haven’t been too popular lately. Investors looking for broadly diversified investments have instead latched onto target-date funds, which tend to own a wider range of securities and conveniently downshift away from equities as investors near retirement (and have made big inroads into retirement plans). However, allocation funds can still be appealing; they often highlight the abilities of one manager or team, while target-date funds typically spread their assets among a large number of managers.
Morningstar divides allocation funds into four categories based on their level of equity exposure and exposure to non-U.S. stocks: aggressive allocation (70%–85% stocks), moderate allocation (50%–70% stocks), conservative allocation (20%–50% stocks), and world allocation (at least 40% in non-U.S. equities and at least 10% in bonds). This Morningstar Principia screen helps identify funds from these categories that boast experienced managers, modest costs, and fine records while keeping risk in check.
( Morningstar Category = Aggressive Allocation
Or Morningstar Category = Moderate Allocation
Or Morningstar Category = Conservative Allocation
Or Morningstar Category = World Allocation )
And Special Criteria = Distinct Portfolios only
And Purchase Constraints does not equal Closed-New Investment
And Purchase Constraints does not equal Qualified Access
And Min. Initial Purchase <= $10,000
And Analysis does not equal NA
And Manager Tenure (Longest) >= 5 years
And % Rank Category 5 year <= 25
The next step is to limit the pool of candidates to funds where at least one manager’s been at the helm for five years and that have outpaced a minimum of three fourths of their category peers over that period. While we have sometimes extended these criteria to 10 years, the tumultuous market environment of the past five years makes for an impressive proving ground for investors.
And Fee Level % Rank <= 50
And Morningstar Risk does not equal High
Finally, let’s eliminate funds that charge above-average fees or take shareholders on a wild ride.
Here are some of the funds that cleared this screen in Principia as of March 5:
Berwyn Income BERIX
While it isn’t one of the more prominent allocation funds out there, this $1.3 billion fund has already closed to new investors once (and has since reopened). The management team of George Cipolloni, Ray Munsch, Lee Grout, and Bob Killen limits the fund’s equity stake to 30% tops; within that slice, they look for companies of all sizes that don’t carry too much debt, have decent growth prospects, and sell for undemanding valuations. The rest of the fund is composed of bonds and cash. The team rarely owns a significant stake in Treasuries (indeed, the fund recently didn’t own any), instead playing to its strength— individual company analysis—by focusing on corporate debt. The managers tend to avoid companies with the diciest balance sheets, but they will own some high-yield debt. In late 2010, the dearth of new, attractive ideas in that area (along with significant inflows) caused the fund’s cash stake to build, so it was closed to new investors. The cash hoard was worked down, primarily in the markets’ slide in the third quarter of 2011, and the fund reopened last fall. That type of good steward- ship, along with a modest 0.66% expense ratio, has led to stellar returns here. This is a solid, under-the-radar choice for investors looking for light equity exposure.
Leuthold Core Investment LCORX
This fund’s namesake and manager since its 1995 inception, Steve Leuthold, took a step back last fall—he’s no longer a named manager and is reducing his workload a bit at the firm. But he’s still involved in the invest- ment process that has served shareholders well over the years. The fund actively allocates assets based on the firm’s view of the relative valuations of stocks, bonds, cash, and commodities and macroeconomic factors, and the portfolio changes quickly at times (its equity weighting typically ranges from 30%–70% of assets). It won’t shy away from varied investments such as emerging-markets equities and bonds, as well as physical metals (particularly gold), and it will own companies of all sizes. As a result, the fund’s returns can be streaky and volatile at times—indeed, the fund is in the midst of a stretch of very poor relative returns. But it’s delivered the goods over time, outpacing more than 80% of its aggressive-allocation peers over longer periods.
There’s good reason to think that success will continue. Leuthold still participates in the macroeconomic calls that drive the process, and the remaining three managers have been with the firm for an average of 12 years.
T. Rowe Price Capital Appreciation PRWCX
This is another wide-ranging fund: Manager David Giroux invests in stocks, convertible bonds, traditional investment-grade and high-yield bonds, leveraged loans, and cash. The portfolio isn’t as actively traded as the Leuthold fund’s, however, and Giroux focuses heavily on bottom-up fundamental factors rather than macroeconomics.
Giroux tends to keep 60%–65% of the fund’s assets in stocks and takes into account the equitylike characteristics of the convert- ibles sleeve when considering its overall equity exposure. That convertibles stake has generally shrunk as that market has become pricey, in Giroux’s view, although convertibles’ lack of liquidity also makes it difficult for the growing, $12 billion fund to invest heavily in them. He’s found other ways to add value, though. His taste for undervalued blue-chip stocks has met with solid results during his 5.5-year tenure, and a rising stake in leveraged loans has worked out well, too. The fund has been more volatile than the moderate-allocation norm under Giroux because of his willingness to add to stocks as they drop (as well as above-aver- age total equity exposure). But during his tenure, Giroux has outperformed the bench- marks within its equity, bond, and convertibles portfolios and generated superb returns.
Vanguard Wellington VWELX
This fund’s simple formula has remained the same for decades: Invest close to two thirds of assets in the stocks of very large, undervalued companies that pay substantial dividends, stash the rest in government-backed and higher-rated corporate debt, hold for the long term, and charge low fees. Current managers Ed Bousa and John Keogh have proved to be worthy successors to their colleagues at Wellington Investment Management at this fund. Each has been managing money for motr than 30 years, and their security selection has been good. That, along with the fund’s 0.27% expense ratio, has meant top-flight returns over the past five and 10 years. And the fund’s low costs mean the managers haven’t had to take a lot of risk to outperform, so the fund has been less volatile than most of its peers to boot. As a result, investors have used the fund well, as measured by its dollar-weighted returns.