How We Rate Allocation Funds

Allocation funds are different beasts than most of the funds we rate. While other funds typically focus on one asset class and often have one manager and strategy, allocation funds usually own a mix of stocks and traditional bonds and possibly convertible bonds, preferred stocks, and options as well) and frequently employ multiple managers employing various approaches to investing.

Thus, we look closely at both the equity and fixed-income portfolios of an allocation fund and the personnel and strategy behind each. Has management added value in both asset classes, and what is the likelihood it can do so in the future? Two excellent funds,  Oakmark Equity & Income (OAKBX) and  T. Rowe Price Capital Appreciation (PRWCX), serve as good examples. Clyde McGregor, lead skipper of the Oakmark fund, has built a formidable stock-picking record in 18 years at this fund and more than a decade at Oakmark Global (OAKGX). He’s long focused on stocks that look cheap on absolute--not relative--terms with a great deal of discipline that makes the process quite repeatable. He’s also backed by a squad of topnotch equity analysts and other portfolio managers. The fund’s bond sleeve, however, has been unremarkable: It typically doesn’t venture much beyond the U.S. government-backed debt market (a largely efficient area), and the fund’s advisor, Harris Associates, offers no pure bond funds and has a very modest fixed-income research effort.

The T. Rowe fund, meanwhile, has a record of adding value in both stocks and bonds (both investment-grade and high-yield traditional bonds as well as convertibles and leveraged loans) during manager David Giroux’s nearly eight-year tenure, and the firm boasts a solid fixed-income team. The difference in the two funds’ fixed-income operations, along with the T. Rowe fund’s lower fees, largely drive our greater confidence in T. Rowe Price Capital Appreciation, which earns a Morningstar Analyst Rating of Gold rating, while the Oakmark fund earns a Silver (which is still an impressive feat).

More Than Meets the Eye
When allocation funds feature multiple managers who run the underlying stock or bond charges, we naturally take into account our ratings of those component funds. We aim for consistency, but it’s not as simple as merely asset-weighting those other ratings to arrive at a conclusion. A multifaceted approach is needed. Take  Janus Balanced (JABAX) as an example: The fund's equity and bond portfolios have been managed by Marc Pinto and Gibson Smith, respectively, since 2005. Smith also runs the Silver-rated  Janus Flexible Bond (JAFIX), managing this fund’s bond sleeve in much the same way. Pinto, meanwhile, has steered Neutral-rated  Janus Growth & Income (JAGIX) since 2007, earning subpar results, and took over Neutral-rated  Janus Twenty last year. Because Balanced typically holds at least 60% of its assets in equities and the rest in bonds, asset-weight averaging the ratings would suggest a Neutral or a Bronze rating at best. But the fund is greater than the sum of its parts. Smith also sets the fund’s asset mix and has added value in that way. Pinto tends to own more dividend-paying firms at Balanced than at his other two charges and has also generated better returns here, and the fund has fared relatively well in both strong and weak markets. Those nuances help to explain the Silver rating for Balanced.

Even when an allocation fund has numerous sleeves run autonomously by managers who employ the same strategies at their primary charges, a sum-of-the-parts analysis isn't enough--other issues still have to be considered. Take  T. Rowe Price Personal Strategy Balanced (TRPBX). Morningstar covers nine of the 10 underlying strategies used; four earn a Silver rating, while three earn a Bronze and two earn a Neutral. Asset-weighting here would lead to a Bronze, but the asset-allocation committee that makes modest shifts here is composed of the firm’s most accomplished portfolio managers, and the fund taps the talents of many other investment staffers at this stable firm (which earns a Positive Parent rating). Finally, the fund is quite cheap relative to its typical no-load moderate-allocation peer. It all adds up to a Silver rating for the fund.