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Keep an Open Mind on Open-Minded Funds

Excessive focus on style or geographic allocation can be limiting.

Gregg Wolper, 09/16/2014

Many financial advisors consider asset allocation one of their main contributions to their clients' success. And they often extend that idea to include allocation within asset classes. In the aftermath of the global financial crisis of 2007-08 and the eurozone-fueled upheavals of 2011, diversification is viewed as even more critical than before. Thus, many advisors will recommend owning a growth fund to balance a value fund, emerging-markets funds in addition to those targeting the U.S. and developed international markets, and may also include a variety of other asset classes besides stocks and bonds.

Diversifying certainly has merit. Over the past decade and more, we've heard too many stories of investors who had the bulk of their retirement funds in company stock that became worthless, or who had loaded up on aggressive equity funds with little attention paid to anything that might hold up better when stock markets declined. Including different types of stock and bond funds, and perhaps other assets as well, can--at least in theory--help investors avoid panic and stick it out through rough patches, because at least a few of these funds should hold up decently well even if others are struggling.

Some advisors take this approach to the furthest extent. They buy only mutual funds or exchange-traded funds that restrict themselves to very specific, and sometimes very narrow, mandates. Along with the advantages, though, there can be costs to taking this strategy that far.

The Benefits
People who invest this way have certain advantages. They know how much of their assets or their clients' portfolios is devoted to bonds, stocks, or other asset classes at any particular time. They also know the percentages of assets invested in U.S. versus foreign holdings, how much is in emerging markets, and even how much of the portfolio falls into specific sections of the Morningstar Style Box, such as large growth or small value.

With asset-allocation and style decisions taken out of the hands of a portfolio manager, advisors and investors can decide for themselves whether to maintain or change those allocations, and then monitor them to ensure they're getting exactly, or almost exactly, the allocations and style diversification that they want.

What This Approach Gives Up
In exchange for that certainty, those who take this route do risk missing out. There are many funds, both active and passive, that don't limit themselves to owning just one type of asset, or don't fit neatly and consistently into one portion of the style box, and yet are worthy of consideration.

These include the most wide-ranging, "go-anywhere" funds. But far more numerous are the many less-adventurous funds that happen to, say, occasionally buy some high-dividend stocks along with bonds to attain income, or whose portfolio simply moves from one side of a style-box border to another at times, depending on where the manager finds the most attractive opportunities.

One can build a reasonable and rewarding portfolio without looking at any of these choices, but including them provides a broader canvas from which to choose.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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