Choose Your All-Weather Fund with Care
Some moderate-allocation funds have risks you shouldn't ignore.
Moderation-allocation funds have attracted quite a bit of attention since the beginning of the last bear market. In fact, they've continued to attract attention even after this past year's turnaround: For example, they received nearly $5.5 billion in net inflows in April, according to Financial Research Corporation, which is $1.3 billion more than the runners-up, large-value offerings, collected. And moderate-allocation funds have also been the most popular type of offering for the year to date, with approximately $23 billion in net inflows.
This doesn't come as a shock. The moderate-allocation category contains well over 300 offerings, and many of its members are well established and successful funds that work quite well as core holdings. What's more, these funds mix stocks and bonds in one portfolio, and thus offer more stability than all-stock funds, but better capital-appreciation potential than funds devoted solely to bonds. Therefore, they have understandable appeal in tumultuous conditions.
But make sure you do your homework before buying or adding to a moderate-allocation offering right now. For one thing, all funds in the group are not the same--not even close. Though a sizable majority of these funds focuses on larger-cap-blend or larger-cap-growth stocks, many concentrate on value or smaller-cap names. These value and smaller-cap fans have enjoyed a substantial advantage over the majority in recent years--and have generally performed quite well--because the types of stocks they favor have fared far better than growth and large-cap stocks in the early 2000s. But take care: Bargain- and smaller-cap-oriented moderate-allocation funds do come with risks that shouldn't be ignored.
American Funds American Balanced (ABALX) received approximately $5.3 billion in inflows in the first four months of 2004, which is tops among all moderate-allocation offerings and second among all funds. This isn’t a surprise. The fund began the year with close to $30 billion in assets; it boasts an excellent long-term record; and it's part of one of the most respected families around. What’s more, it posted its fourth straight strong year in 2003, thanks to its good stock selection as well as its hard-core large-value discipline. Just remember that the fund's emphasis on cheap blue chips can leave it lagging, as its subpar late-1990s returns attest.
American Funds Income Fund of America (AMECX) hasn’t attracted quite as much money as its sibling this year, but it has seen roughly $3.8 billion in inflows and remains the biggest moderate-allocation offering around. That makes sense given its impressive overall risk/reward profile and other attributes. Nonetheless, it's crucial to note that management's commitment to dividend-paying stocks, which was a boon in recent years, was a burden in the late 1990s and is likely to weigh the fund down whenever tech and other growth stocks lead the way. Moreover, this fund's considerable girth severely limits its agility.
Oakmark Equity & Income (OAKBX) is another popular moderate-allocation offering that looks especially good these days. This fund grew from less than $60 million in assets at the end of 1999 up to roughly $7 billion in late April 2004, as it crushed its peers during each of the first four years of this decade. Oakmark, wisely, just closed this fund to certain brokers and intermediaries, so asset growth isn't likely to be a big problem here going forward. That said, this fund is a hard-core bargain hunter and has the freedom to make full use of the market-cap spectrum, so its strategy has been quite in favor in recent years. It won't always find itself in the market's sweet spot.
Finally, as always, don’t just pick names from the top of the performance charts. For example, it's important to note that Greenspring (GRSPX) and several of the other moderate-allocation funds that boast the best three- and five-year returns at present have benefited from their taste for smaller caps as well as their miserly natures. Greenspring, in fact, normally sports one of the smallest average market caps in the moderate-allocation category plus big overweights in the financials and other traditional value sectors. Though these sorts of biases have been quite advantageous in the early 2000s, they also can backfire, as Greenspring's poor late-1990s showings make clear.
In short, it's essential to understand that many of the popular and successful moderate-allocation funds have enjoyed a real tailwind in recent years and that they are unlikely to do as well when conditions change and they encounter a significant headwind. Moreover, while American Funds American Balanced, American Funds Income Fund of America, Oakmark Equity & Income, and even Greenspring remain good long-term holdings for the right investors, moderate-allocation fans shouldn't forget about Pax World Balanced (PAXWX) and some of the other more-talented growth vehicles in the group.
William Samuel Rocco does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.