Balanced Funds For the Risk-Averse

Many investors with a long-term horizon who are leery of timing the market often consider balanced, or hybrid mutual funds. These funds provide capital appreciation and income by investing in both stocks and bonds. They typically allocate 60% of their assets to stocks and 40% to fixed-income securities. Portfolio managers may vary these proportions, depending on overall market conditions.

Despite the instant diversification that they offer, balanced funds appear to be less popular this year than last. According to the Investment Company Institute, hybrid funds had inflows of only $647 million through the first two months of 2006, versus inflows of $9.32 billion for the same period a year ago. "Inflows into balanced funds have suffered because investors are pouring money into the equity markets and stock funds," says Lou Harvey, president of Dalbar Inc., a Boston-based mutual fund consulting firm. "But, I think that in the coming years, balanced funds will become increasingly attractive because they make the most sense for the retirement investor."

For the ten-year period ended April 28, the average balanced fund returned 7.4% annualized, versus a gain 8.8% for the average domestic equity fund, according to Standard & Poor's data. Still, a number of balanced funds have put up competitive returns compared to pure equity offerings. Below is a sampling of balanced funds that have delivered strong performance over the past three years and carry relatively modest expense ratios. All of the funds profiled are open to new investors.

Bruce Fund (BRUFX)

One of the top-performing funds of this style, the $188-million Bruce Fund (BRUFX), is its own kind of balanced fund. Co-manager Jeff Bruce says he makes no attempt to strategically allocate investments among asset classes. Rather, Bruce seeks out the most attractive capital appreciation opportunities available, whether they are in stocks or in bonds. He and co-manager Robert Bruce set no limits on their asset allocations.

The fund has soundly beaten both the S&P 500 and the average hybrid fund for the one-, three-, and five- year periods through March 2006. In fact, it delivered outstanding returns of roughly 60% in each of calendar 2003 and 2004. Although the fund boasts a low turnover rate of 10.1%, the securities in the portfolio are themselves volatile For example, the fund has a high standard deviation of 14.5, versus 6.2 for the peer group, indicated that it is riskier than its peers. The equity portion includes small- and micro-cap stocks, some in turnaround situations; while the fixed-income component includes short- to intermediate-term bonds selling at significant discounts to par.

In addition, the fund also has a sizable cash position; money-market instruments represented 21.5% of assets at the end of 2005. At that time, the fund had a 46.4% stake in common stocks and 31.0% in bonds, including 23.0% in corporate convertibles. While this fund has a higher risk profile than others in the group, it has also delivered consistently higher returns.

Mairs & Power Balanced Fund (MAPOX)

Another relatively small portfolio, the $126-million Mairs & Power Balanced Fund (MAPOX) boasts long-term performance against style peers. It also has low turnover (13.5%, vs. 55.7% for peers), and a modest 0.84% expense ratio. "This fund was designed to complement our all-equity Mairs & Power Growth Fund (MPGFX)," said lead manager William Frels. "The equity portion of the balanced fund seeks stocks showing consistent growth, regardless of size. However, we only purchase dividend-paying stocks, so that our equity component is more conservative than a typical growth equity fund."

Frels typically keeps 60% of the portfolio in stocks and 40% in bonds. "We don't move around much -- our equity allocation ranges between 55% and 65%, depending on our outlook for the stock markets," he says. Frels attributes the fund's recent outperformance to a slight overweight in the energy secto. Meanwhile, the fund's bond portion typically consists of highly rated securities trading at significant discounts. However, Frels said he currently has some junk bonds issued by automobile companies. "When we bought them they were of investment-grade quality, but we held onto them because we think the rating agencies have become too conservative with regard to credit risk," he noted.

As of Dec. 31, 2005, the Mairs & Power Growth had a 62.7% allocation to stocks and 35.0% to fixed income securities, consisting of 20.4% in federal agency obligations and 14.2% in corporate bonds. "We are finding more value in federal agency bonds as they provide good yield relative to corporates," Frels says.

Fidelity Balanced Fund (FBALX)

The large $19.2-billion Fidelity Balanced Fund (FBALX) seeks to maintain 60% in equities and 40% in bonds and cash. The portfolio has beaten its peers over the one, three- and five-year periods through March 2006. Manager Lawrence Rakers's stock selections tend to have a value orientation, and they typically pay dividends. "The manager looks for value stocks that are cheap relative to their own history or their industry," says a Fidelity spokesperson. "In the equity portion, the dividend yield was 1.3% as of March 31, 2006 and most of the stocks paid dividends."

Fidelity says that the fund invests in a broad range of bonds, including government, corporate, mortgage-backed, and asset- backed securities. The fund is not limited to high quality, and it has had a modest high-yield element. Top sectors as of March 2006 were financials, 12.6%; information technology, 11%; energy, 8.6%. About 66% of the fund's assets were invested in stocks as of March 31, but that figure has been steadily declining: Equities accounted for 70.3% of total assets at the end of September 2005. With more than 1,200 holdings, the fund features a relatively high turnover rate.

Value Line Income & Growth Fund (VALIX)

The $328-million Value Line Income & Growth Fund (VALIX) has outperformed its style peers over the short and long term. Manager Sigourney Romaine had 59.9% of her assets in stocks, 22.9% in bonds, 11.2% in cash, and 5.7% in convertibles of March 31. She can invest in equities of any size, but typically focuses on larger-cap issues that pay dividends. She believes such securities provide a stable and reliable source of income, regardless of the fluctuations in share price and earnings. Fixed-income selections generally have credit ratings ranging from the highest (AAA) to medium (BBB) at the time of purchase. However, this fund sports a turnover rate of 103.00%, roughly double the peer group average of 55.7%, and an expense ratio 1.11% slightly higher than the peer average 0.92%.

Fund Name

One-Year Total Return* (%)

Three-Year Annualized Return* (%)

Five-Year Annualized Return* (%)

S&P Star Rank

Expense Ratio (%)

Bruce Fund (BRUFX)

33.7

42.7

33.7

5

1.03

Mairs & Power Balanced Fund (MAPOX)

14.3

13.2

7.3

4

0.84

Fidelity Balanced Fund (FBALX)

21.0

16.8

8.9

4

0.64

Value Line Income & Growth Fund (VALIX)

19.6

17.5

7.5

5

1.11

*SOURCE: Standard & Poor's. Data through April 28, 2006.

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