Plenty of investors traditionally ignored balanced funds, which often hold stodgy mixes of stocks and bonds. But lately, balanced choices have become almost hot. In 2005, the category known as moderate allocation ranked as the top seller, attracting inflows of $58 billion, according to Financial Research Corporation. The new appeal is not hard to understand. After watching aggressive managers collapse during the market downturn that began in 2000, investors are looking for cautious vehicles. Moderate allocation funds built a record for protecting assets by avoiding big losses in hard times and profiting modestly from bull markets.
For advisors who set their own asset allocations, the funds may seem limiting; with a fund, you must accept the allocation choices of the manager. But even for advisors who set their own allocations, the funds can be ideal choices for the children of clients or other accounts that are too small to be diversified easily. And a moderate allocation fund may be an intriguing holding for an advisor who is looking to protect against downside surprises.
Which moderate allocation choice is best? To find the winner, Wealth Manager again turned to screens developed by Donald Trone, chief executive officer of Fiduciary360, a consulting firm in Sewickley, Pa. Trone's due-diligence process seeks funds that are at least three years old and have more than $75 million in assets. One- and three-year total returns must exceed the category medians, as must five-year results if the fund is that old. Alpha and Sharpe ratios must also surpass category medians. The expense ratio must fall below the top quartile, and at least 80 percent of the fund's holdings must be consistent with the category.
Trone's screens whittled down the field from 1,078 funds to 127 contenders. The top five-year performer was Bruce Fund, but we decided to pass by that choice because it takes big risks as measured by standard deviation. Other strong choices--FPA Crescent and Dodge & Cox Balanced--were closed to new investors. Finalists included Leuthold Core Investment and Fidelity Balanced, but we awarded the title to Oakmark Equity & Income I, which had achieved sterling results, posting one of the highest five-year total returns and among the lowest standard deviations.
Oakmark makes no effort to follow the pack. While many allocation funds focus on safe blue-chip shares, Oakmark favors unloved issues. Portfolio managers Clyde McGregor and Edward Studzinski seek stocks that sell for 60 percent of their intrinsic value. In their search for deep-value names, the managers make eclectic picks, holding a mix of spinoffs, troubled businesses, and solid companies with minor problems. The fund owns stocks of all sizes. The managers sell shares after they have risen to 80 percent of fair value. "The ideal stock for us is one that we never have to sell because the company keeps increasing its intrinsic value faster than the shares rise," says Studzinski.
Oakmark currently has 60 percent of assets in stocks with most of the rest in government bonds. The stock allocation can rise to 65 percent when the managers find bargains. When stocks look expensive, equities may account for only 50 percent of the portfolio.
When they spot groups of cheap stocks, the managers sometimes overweight sectors. The fund currently has 22 percent of assets in energy, double the weighting of the Standard & Poor's 500-stock index. "We are not indexers," says Studzinski. "The fact that we deviate from the benchmark does not concern us."
The fund began moving into energy stocks in 2001 when the group was shunned. At the time, the Oakmark managers thought that oil and gas supplies were not keeping up with growing demand. Their thinking proved profitably correct. Studzinski saw special bargains among natural gas companies. "We were buying companies at a substantial discount to what the reserves were worth," he says.
The fund's biggest holding currently is XTO Energy, which explores for oil and gas. Studzinski says the company has proven adept at buying aging fields and raising the production. "This is one of the few companies that is increasing proven reserves dramatically," he says.
Another successful holding has been Nestle, the food giant. While many analysts see the company as a slow grower, Oakmark believes that the company has unusual opportunities to expand. The company has strong lines of bottled water, one of the fastest growing beverages. In addition, Nestle is moving into growing emerging countries. Studzinski likes the fact that the food producer rewards shareholders, raising the dividend and recently buying up huge amounts of the company's own stock, a process that tends to prop up share values.
Studzinski is bullish on Caremark, a pharmaceutical benefit manager. At a time when employers are struggling to hold down costs, Caremark is one of the largest players in the drug management field. The company throws off a healthy amount of cash, but the business does not require a lot of capital investment in new equipment, say the Oakmark managers. Demand should grow sharply in the next several years, Studzinski says.
Careful stock picking has helped Oakmark shine during market downturns. When the S&P 500 suffered big losses in 2000 and 2001, Oakmark produced double-digit returns. When the market rallied in 2003 and 2004, the fund lagged but still produced double-digit results. The steady showing is what the Oakmark managers seek. "When working people put their 401(k)s in our fund, we don't want them to worry that the money will suddenly disappear," says Studzinski.