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Allocation Funds’ 2021 Highlights

Equities dominate, value rebounds, and a behemoth gets big inflows.

U.S. stocks rose sharply in 2021 as the economy and corporate profits bounced back. The S&P 500 posted a 28.7% gain, propelling allocation funds that favor equities to double-digit returns, on average. The allocation--85%+ equity Morningstar Category, for example, posted an average gain of 17.6%.

The bond market, on the other hand, wrestled with the prospect of the Federal Reserve hiking interest rates in the near future to counter surging inflation; the Bloomberg U.S. Aggregate Bond Index declined 1.5% in 2021. Thus, bond-heavy allocation funds typically generated more-muted gains. The average allocation--15% to 30% equity fund advanced just 5.2%.

Non-U.S. stocks didn’t perform nearly as well as their U.S. counterparts, so world-allocation funds’ gains were solid but less strong than other equity-heavy allocation categories. World allocation funds, despite holding an average of 60% of their assets in equities, gained a more-modest 11.3% in 2021. Contrast that with the average U.S.-centric allocation--50% to 70% equity fund, which returned 13.9% with the same amount of equity exposure.

Value-leaning allocation funds didn’t face much of a headwind in 2021, the first time that’s been true in roughly five years. Financial and energy stocks, often favorites of value managers, performed well as the prospect of rate hikes and surging energy prices propelled them higher. Dodge & Cox Balanced DODBX gained 19.3% for the year, surpassing more than 90% of its allocation--50% to 70% equity peers. And those funds that pair their value stocks with more credit risk than peers in their fixed-income portfolios got an additional boost--high-yield bonds outpaced much of the rest of the bond market, with the average fund focused on such debt gaining 4.8%. For example, Oakmark Equity & Income OAKBX gained 21.6% in 2021, beating 97% of allocation--50% to 70% equity peers. Franklin Income FKINX, which typically has a lower equity weighting than the other two, often stashes more than half its fixed-income allocation in high yield and outpaced 98% of peers in the allocation--30% to 50% equity category. Though a tailwind this past year, high allocations to high-yield debt can hurt during sell-offs.

The dozen largest allocation funds at the end of 2021 each outperformed their typical peer, including American Funds American Balanced ABALX, American Funds Income Fund of America AMECX, Vanguard Wellington VWELX, and perennial winner T. Rowe Price Capital Appreciation PRWCX. The biggest fund to substantially lag was Vanguard STAR VGSTX ($28 billion at the end of the year), which gained less than 10% and lagged more than 90% of peers. Several of the fund-of-funds’ holdings lagged badly in 2021, including Vanguard U.S. Growth VWUSX and Vanguard International Value VTRIX. The other big fund that had a disappointing year was GMO Benchmark-Free Allocation VBMFX ($5.3 billion). A doggedly contrarian approach led to a modest equity stake and an emphasis on alternative strategies, resulting in a miniscule 3.0% gain in 2021.

Net Redemptions, but One Big Gainer

Investors pulled roughly $3.4 billion from allocation funds in 2021, continuing a trend in recent years in which investors have gravitated to target-date strategies. The biggest loser among allocation categories was world allocation, which saw $6.8 billion in net redemptions. That marks the seventh straight year of outflows for the category, likely caused by non-U.S. stocks’ persistent underperformance during that period. The allocation--50% to 70% equity category, meanwhile, attracted a net $11 billion--but that was entirely due to a single fund. American Funds American Balanced pulled in $11.9 billion in 2021, more than $9 billion more than any other allocation fund, owing to its strong long-term record. The fund has $223 billion in assets. Capacity hasn’t been an issue, though, as the fund has 10 named portfolio managers running independent sleeves and has long focused on the most-liquid stocks and bonds. Another winner was the DWS RREEF Real Assets Fund AAASX, a niche multi-asset inflation protection strategy that invests in natural resource equities, real estate, infrastructure, commodities, and TIPS. This diversified real asset strategy pulled in $2.7 billion (more than doubling its asset base year over year) as investors flocked to areas that would benefit from rising prices.

Fund flows can be a lagging indicator, and that was certainly true in 2021: Five of the seven allocation funds that had the largest net outflows have value-leaning equity portfolios, and four of those six outperformed their typical category peer in 2021, including the aforementioned American Funds Income Fund of America and Franklin Income.

Muted Ratings Changes

Allocation funds didn’t see big changes to their Morningstar Analyst Ratings in 2021; none moved more than one notch up or down for their oldest share class. The biggest fund to see an upgrade was BlackRock Global Allocation MALOX ($25.7 billion); its cheapest share classes moved to Silver from Bronze. Our confidence in the team has increased now that global fixed-income CIO Rick Rieder, named a comanager in 2019, has demonstrated that he’s marshaling the firm’s wealth of resources behind the fund.

The largest fund to be downgraded was Dodge & Cox Balanced ($15.3 billion), as the rating of its only share class declined to Bronze from Silver. The managers have ramped up risk in recent years through an elevated stake in equities coupled with a large weighting in corporate bonds, resulting in substantial volatility. The team is now ramping up its risk-management efforts, but that project is a work in progress.

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