These Allocation Funds Have Earned Their Keep

You'd be hard-pressed to dream up a more boring investment than  Vanguard Balanced Index (VBINX). Indeed, it's so dull that the fact that it's not truly balanced may be the most interesting thing about it. Management targets a near-constant 60% weighting in the CRSP Total U.S. Stock Market Index and stakes the rest of the portfolio in the Barclays Aggregate U.S. Float Adjusted Index. Its expenses are low. And that's pretty much all you need to know about it.

Yet, the fund may, in fact, be the investing world's ultimate illustration of why less is so often more. Sure, funds that are more equity- or bond-heavy are beating it at various points in time, depending on whether stocks or bonds have recently been hotter. But when you take the long view, the fund has been a surprisingly formidable foe, with a tiny handful of multi-asset-class funds managing to beat it on a risk-adjusted basis over the past 10 years.

In last week's article on asset-allocation mistakes to avoid, I mentioned the perils of being too hands-on with your stock/bond mix. I referenced a previous Morningstar study showing that most tactical asset-allocation funds underperform Vanguard Balanced Index on a risk-adjusted basis over time. In fact, a screen in Morningstar Direct reveals that most funds in Morningstar's newly created tactical asset-allocation category haven't been able to cut the mustard, either. (Prior to the creation of the tactical category, funds with active asset allocations were slotted into Morningstar's conservative-, moderate-, or aggressive asset-allocation groups.)

Of the 17 tactical asset-allocation funds with 10-year track records, just one--the tiny  Stadion Tactical Growth (ETFAX)--has managed to beat the plain-vanilla balanced index fund over the past decade. And it has done so by only a hair--0.19% per year. That's hardly a compelling margin when you consider the extra volatility that has accompanied the Stadion fund--a 10-year standard deviation of 14 versus 9 for Vanguard Balanced Index. The number of tactical funds that have beaten the index over the past decade on the basis of their risk-adjusted returns? Exactly zero.

If most tactical asset allocators haven't been able to get it done, what about the broader universe of all multi-asset-class funds: conservative-, moderate-, and aggressive allocation? These funds tend to maintain fairly static asset allocations. Aggressive-allocation funds typically have 70% to 90% of their assets in stocks; moderate-allocation vehicles stake 50% to 70% in equities; and conservative-allocation offerings typically stake 20% to 50% of their assets in stocks and the remainder in cash and bonds.

Within this broad group of nearly 300 allocations funds that have 10-year records, it is also a svelte list of offerings that have beaten the plain-vanilla balanced index. Just eight funds have both higher 10-year returns and a lower standard deviation than the index. The list is as follows:

AMG Chicago Equity Partners Balanced 
 Berwyn Income (BERIX)
Federated Capital Income (CAPAX)
Hennessy Equity and Income Investor (HEIFX)
James Balanced: Golden Rainbow (GLRBX)
Janus Aspen Balanced (no ticker)
 Janus Balanced (JANBX)
 Vanguard Wellesley Income (VWINX)

Of course, there's no guarantee that all of these funds will outperform in the future; they may have had a stylistic tailwind, such as emphasizing lower-quality bonds, that helped over the past decade but could be a hindrance going forward. Here's an overview of three of Morningstar's favorite funds that made the cut.

 Berwyn Income (BERIX)
Morningstar Category: Conservative Allocation | Morningstar Rating: Silver
Given that stocks outperformed bonds over the past 10 years, it's all the more striking that this fund, with an even more conservative asset allocation than its typical conservative-allocation peer, has also beaten most of its rivals in the more stock-heavy aggressive- and moderate-allocation groups. Its equity stake can't exceed 30% of assets, though management has made good use of junkier bonds, convertibles, and preferred stocks when it has thought they've looked attractive. Whether the fund will acquit itself as well in what promises to be a low-returning bond environment over the next decade or two is an open question, and the fund is also in the midst of a management transition, as veteran manager Ray Munsch retired in January 2014. But analyst Greg Carlson is sanguine about the remaining comanagers and two new additions to the management team, and notes that management has historically done a good job of taking on--or downplaying--credit risk as market conditions dictate.

 Janus Balanced (JANBX)
Morningstar Category: Moderate Allocation | Morningstar Rating: Silver
This fund's current management team was not on board for the entire 10-year period; fixed-income manager Gibson Smith and equity manager Marc Pinto took over in May 2005. But they've demonstrated some skillful maneuvers during that period. Analyst Greg Carlson notes that the pair doesn't typically vary significantly from the standard 60% equity/40% bond weighting; but when they have made shifts, they've often been beneficial. In 2008, for example, they took their portfolio's equity weighting down to just 39% of assets--a primary reason why the fund held up better than the vast majority of funds in its category. While the stock and bond components of some allocation funds are managed without too much consideration for how the two parts work together, that's not the case here. Carlson notes that if Pinto is taking more risk with the equity portfolio, for example, Smith will step down the risk in the fixed-income portfolio. The fund is bound to have the periodic off year, but its sensible strategy along with Smith and Pinto's experience argue in its favor.

 Vanguard Wellesley Income (VWINX)
Morningstar Category: Conservative Allocation | Morningstar Rating: Gold
This stalwart, a favorite among Morningstar.com readers, has not only a phenomenal track record but good fundamentals, too. Its comanagers, John Keogh on bonds and Michael Reckmeyer on equities, both of Wellington Management, have been on board here for six years; but both had decades' worth of investing experience before taking the reins. The fund's strategy of holding 60% to 65% of assets in bonds and 35% to 40% in stocks--while too conservative for young accumulators--has held it in good stead through a broad range of market environments, aided in part by stellar security selection. The one potential knock against the fund is its interest-rate sensitivity. Not only does its bond portfolio have a duration of more than six years but its dividend-focused equity stake could also prove vulnerable in a period of rising rates. Analyst Kevin McDevitt notes, however, that the fund acquitted itself well in 2013's midyear interest-rate shock as the equity holdings thrived even as bonds stumbled.

Morningstar's Christine Benz will be speaking at the 12th Annual Financial Fitness Workshop, organized by the Financial Planning Association of New York, on Saturday, September 27. For more details about the event, click here.

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