Allocation Funds that Guard Against Rising Rates

Rising interest rates have reminded investors that bonds can be risky, too. Moderate allocation funds, which typically have 30% to 50% of their assets in fixed income and cash, have been big sellers lately because of their mild risk levels, yet they can still pack some interest-rate risk. So, investors seeking to tone down their equity risk have to be careful they don't walk into a fund that will get clobbered by rising rates.

So far, those risks have been muted by a rallying stock market, but it's worth taking note of an allocation fund's duration (a measure of interest-rate risk) before diving in. In the conservative allocation category, where funds have more in bonds than stocks, some have taken it on the chin.  Scudder Target 2013 , for example, lost 5% in just the past four weeks because it has a slug of zero-coupon bonds in its portfolio.

I've culled some of the better funds with durations under 3.5 years--a point at which you're likely to lose less than most allocation funds in a rising-rate environment. The bond industry benchmark Lehman Brothers Aggregate has a duration of 4.3 years, and most moderate allocation funds have durations fairly close to that figure.

 Pax World Balanced  (PAXWX)
This fund has produced appealing long-term returns without taking big chances on the bond side. Its duration is just 3.00 years and its average credit quality is AA. It's a little bolder on the stock side, as manager Chris Brown takes a growth-at-a-reasonable-price approach that leads the fund to hold more health-care and tech names than most funds in the category. The fund also employs socially conscious screens that keep it out of defense contractors and companies that are big polluters. Although the market has favored value for much of the past five years, this fund's five-year returns are better than four fifths of the moderate allocation category.

 Greenspring  (GRSPX)
This fund actually runs a higher-risk bond portfolio than most, but its risk is credit risk--not interest-rate risk. The fund's high-yield focus keeps duration down to just 1.70 years. The nice thing about high yield is that the yield is large enough to cushion the blow when rates rise. The stock portion is unusual, too, because manager Chuck Carlson focuses on small-value stocks, whereas most moderate allocation funds run either large-value or large-blend strategies. So, this fund is a good choice only if you have built up a good core portfolio of funds but don't have exposure to small-value or high-yield bonds. One other caveat: Both small value and high yield have been on a roll lately, and they may be due to cool off while other parts of the market outperform them.

 Gabelli Westwood Balanced AAA  (WEBAX)
This fund is a more traditional allocation fund. Lead manager Susan Byrne runs a straight-forward value strategy that emphasizes deep-value turnaround stories and stocks with big dividends. On the bond side, the fund runs a high-quality, short-duration strategy. The experienced Byrne has put up a great record here as the fund's 10.6% 10-year annualized return tops those of 90% of the moderate allocation universe.

Poll Results
On Monday, I asked for your favorite for bond fund Manager of the Year. This is how you voted:

39.0% - Fidelity's muni team (FHIGX)
31.7% - Andrew Dudley (FSHBX)
15.4% - Margie Patel (TAHYX)
13.9% - Western Asset Core management team (WATFX)