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Fund Spy

Beware of Lead Balloons

Investors should take a closer look at what's in the bond sleeve of their allocation funds.

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Allocation funds are typically used as a one-stop shop or as a core holding for an investor's portfolio. Investors holding allocation funds have come to expect the fund's stock sleeve to be the main driver of returns (for better or worse) and for the fund's fixed-income sleeve to provide some ballast when the going gets rough. We wouldn't expect any allocation fund to have been immune from the market's recent turmoil, with Morningstar's stock fund categories down 14% to 60% over the trailing 12 months through March, and all but three of our fixed-income fund categories are also in the red.

Even so, the dispersion of recent results in our allocation fund categories is eye-opening. The average conservative-allocation fund has lost 19% over the trailing 12-month period, with 53 percentage points separating the best- and worst-performing funds. A 28% loss marks the average among moderate-allocation funds, with a whopping 68 percentage points dividing the winners and losers. World-allocation funds have posted an average loss of 29%, with results spanning a gap of 54 percentage points. In each category, the gap between the penthouse and the basement is more than three times each category's range of returns over the trailing 10-year period.

Investors may have overlooked the fixed-income sleeves of their allocation funds, but we're disappointed at the lead balloons in some allocation managers' fixed-income portfolios. Some missteps stem from relatively straightforward sources. Meaningful bets on nongovernment mortgage-backed securities have taken a toll on funds such as  UBS Global Allocation (BPGLX). Big stakes of beaten-down high-yield corporate bonds are weighing on the performance of the income-oriented funds in the conservative- and moderate-allocation categories, such as Evergreen Diversified Income Builder (EKSAX). Those stumbles are at least understandable when considering the cash bonds their managers bought.

Michael Herbst does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.