Potential Allocation Manager of the Year Winners

It's time to start assessing who might win Morningstar's third Allocation Fund Manager of the Year award. My colleagues Dan Culloton and Bill Rocco have already discussed potential winners for Domestic Stock and International Stock, respectively.

The awards are based not only on strong performance in the year in question, but also superior longer-term returns, the depth of the overall management team, a proven strategy, solid stewardship, and a history of serving a sizable group of shareholders well. Some of these factors can't be captured in a quantitative screen, but to come up with a preliminary list of allocation candidates, I screened the aggressive-, conservative-, moderate- and world-allocation Morningstar Categories for the following factors: actively managed funds that earn Gold, Silver, or Bronze Analyst Ratings; funds that have at least one manager who's been on board for seven years (and thus steered the fund through the most recent bear market); and funds that have earned top-quartile returns in 2014 through Nov. 11, 2014, as well as over the trailing five and 10 years.

Below are the eight funds that made the list. With six weeks to go in 2014, the results of this screen could easily change before the year is out.

A Former Winner Is Back in the Hunt
Since winning the inaugural Allocation Manager of the Year award for 2012, David Giroux of Gold-rated  T. Rowe Price Capital Appreciation (PRWCX) hasn't missed a beat. The fund surpassed more than 95% of its moderate-allocation peers in 2013, and it has repeated that feat this year through Nov. 11 with an 11% gain that doubles the category norm. As usual, security selection in both the equity and fixed-income portfolios has been solid. Stock picks ranging from value plays such as utilities  Xcel Energy (XEL) and  PG&E (PCG) to growth names that include drugmakers  Allergan and  Zoetis (ZTS) have boosted returns. Within the fund's fixed-income portfolio--which bears little resemblance to those of most peers--leveraged loans have continued to be winners for the fund, as have BB rated bonds (the higher-quality end of high yield). In response to a rising tide of inflows--a result of the fund's superb record since Giroux took the helm in 2006--the fund closed to new investors in June to help preserve its flexibility.

A Pair of American Funds Behemoths
 American Funds American Balanced (ABALX) and  American Funds Income Fund of America (AMECX) (each is a Silver-rated moderate-allocation fund with more than $75 billion in assets) have been on a tear lately. Both funds have hiked their equity stakes in recent years (above 70% of assets at times), in part because of compelling valuations--although Income Fund also made this move to help meet its yield target amid historically low bond yields. Higher equity weightings have been beneficial for much of the past 5.5 years as stocks have largely thrived, including in 2014, with the exception of a modest dip in early fall. Thus, both funds have outpaced more than three fourths of their peers in 2014 through Nov. 11 as well as over the trailing three and five years. American Balanced has been powered in 2014 by longtime holdings such as  Microsoft (MSFT),  Wells Fargo (WFC), and  Home Depot (HD). Income Fund received a boost from  Merck (MRK), Microsoft, and  Pepsi (PEP).

American Balanced has trimmed its equity stake during 2014 back to a more typical level (64% at the end of September), but Income Fund remains fairly stock-heavy with a 70% weighting. Both funds boast strong longer-term records as well as veteran management teams--seven of Income Fund's nine skippers have served on the fund for more than a decade; the same is true of three of the Balanced fund's eight managers.

Two Vanguard Funds Run by a Topnotch Subadvisor
The equity and bond portfolios of  Vanguard Wellesley Income (VWINX) and  Vanguard Wellington (VWELX) (both Gold-rated funds) have long been subadvised by Wellington Management Company, and the results have been superb: Vanguard Wellesley has surpassed more than 85% of its conservative-allocation peers over the past three, five, 10, and 15 years, and Vanguard Wellington has been similarly successful versus the moderate-allocation category. Vanguard's rock-bottom fees have given both funds a leg up on peers, but security selection by the funds' veteran skippers--Edward Bousa and John Keogh at Wellington and Michael Reckmeyer and Keogh at Wellesley-- has been strong as well. They have continued to make the right moves in 2014, as both funds have outpaced 90% of their peers through Nov. 11. Vanguard Wellington's above-average stake in equities (64% of assets) relative to its typical peer (which holds 58% in stocks) has helped, as have picks such as Microsoft,  CVS Health (CVS), and  Apple (AAPL). Vanguard Wellesley has also sported a larger equity weighting than its typical peer (38% of assets vs. the conservative-allocation norm of 34%) and received a boost from holding Microsoft, Wells Fargo, and  Intel (INTC). (Bousa and Reckmeyer's equity-only charges,  Hartford Dividend and Growth (IHGIX) and  Vanguard Equity Income (VEIPX), respectively, are also performing well in 2014.) Also, both funds have been more sensitive to interest rates than peers because of higher credit quality and longer durations (both funds' bond portfolios stay within one year of their benchmarks' durations, while many peers have gone shorter). That's been a boon as bond yields have fallen in 2014.

A Mixture of Offense and Defense
Since 2007, Ramin Arani has managed the equity portfolio of Bronze-rated  Fidelity Puritan (FPURX) and set its stock/bond split. The neutral weighting is 60/40, but Arani has been correctly bullish on equities (which have weighed in at about 70% of assets here lately). That's one reason why the fund has beaten more than 90% of its moderate-allocation peers during the past three and five years as well as in 2014 through Nov. 11. Also, in addition to the usual suspects such as Microsoft and Apple, Arani (who ran health-care sector funds for Fidelity earlier in his career) has added value this year with picks such as British drugmaker  Actavis and biotech giant  Amgen (AMGN). Meanwhile, fixed-income managers Pramod Atluri and Harley Lank have attempted to provide ballast for Arani's big slug of growth stocks by limiting interest-rate bets versus the Barclays U.S. Aggregate Bond Index, thus providing a boost in 2014 as rates have fallen.

A Yield-Seeker
Bronze-rated  Franklin Income (FKINX) takes significant risks. Because the fund attempts to generate substantial income, it often sports a hefty stake in high-yield debt--more than 90% of its bond portfolio at the end of September, 5 times the conservative-allocation norm. The fund also typically holds outsized stakes within the equity portfolio in sectors known for dividends, such as utilities (one fourth of the equity portfolio in September). However, under the leadership of Ed Perks (its lead manager since 2002), the fund has compensated investors for its risks, surpassing more than 95% of peers over the trailing three, five, and 10 years through Nov. 11. The fund's 2014 gain of 6% through that date tops 85% of its rivals. Perks has gradually raised the fund's equity weighting from 34% in 2009 to 49% in September 2014 (40% above the category norm) as he's found more stocks offering growing dividends. That shift has paid off in 2014, as have picks such as utilities  Exelon (EXC) and  Southern (SO), as well as Merck. The fund's double-digit stake in convertible bonds, meanwhile, also provided a modest boost. The fund's size ($94 billion) is of some concern; its pools of high-yield bonds and converts are larger than those held by most stand-alone high-yield and convertibles funds.

Finding Value and Income Across the Globe
The managers of Bronze-rated  Thornburg Investment Income Builder (TIBAX) have plenty of leeway to invest where they find appealing valuations and dividend yields. That has lately meant a stake in equities north of 85% of assets, well above the world-allocation norm of 61%. The fund's large slug of stocks, which has contained 2014 winners such as China Mobile and Swiss drugmakers Novartis and Roche, has led to a top-quintile 6% gain for the year through Nov. 11. But the fund has also excelled over the long haul; lead manager Brian McMahon has overseen a streak in which the fund outpaced the majority of its peers in nine of the 10 calendar years prior to 2014, lagging only in 2008's decline. And while the fund looks quite bullish on stocks now, that's not a constant--its equity stake has dropped below 55% in the past.

For a list of the open-end funds we cover, click here.

For a list of the closed-end funds we cover, click here.

For a list of the exchange-traded funds we cover, click here.

For information on the Morningstar Analyst Ratings, click here.