When the markets began tumbling in the fall of 2007, investors were hard pressed to find secure assets. During the 12 months ending in January, the Standard & Poor's 500-stock index lost 2.3 percent, and most domestic equity funds dipped into the red. But not all funds lost. Among the standouts was the conservative-allocation category, which returned 2.3 percent during the period. These allocation funds own a mix of stocks, bonds and other assets.
Plenty of advisors dismiss the conservative funds. In a typical example of the category, the portfolio manager sets the asset allocation--often putting most of the holdings into fixed income. This makes the funds unwieldy for advisors who want to set their own asset allocations. But the conservative funds can play useful roles. At a time when many clients may be fearful, a top-performing conservative allocation fund can help to stabilize a portfolio in downturns--while still offering some growth opportunities in better times. For children or clients with small portfolios, the funds may be ideal choices, providing a core holding that will protect their nest eggs.
Which fund is the best choice? To make a selection, Wealth Manager again turned to the eight-part screens developed by Donald Trone, chief executive of FI360, a consulting firm in Sewickley, Pa. Trone's due-diligence process seeks funds that have more than $75 million in assets and are at least three years old. One- and three-year total returns must exceed the category medians, as must five-year results if the fund is that old. Alphas and Sharpe ratios must also surpass the 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.
The screens reduced the field from 554 down to 80 finalists. Among the top finishers were Franklin Income, Janus Balanced: Golden Rainbow, and Columbia Thermostat. But we awarded the title to Permanent Portfolio, which had the highest alpha of the group.
Permanent Portfolio achieved its record by following an unusual strategy that is designed to stay broadly diversified. Manager Michael Cuggino always holds a range of asset classes, including investment-grade bonds, gold, silver, growth stocks, natural resources stocks, real estate investment trusts, and Swiss francs. "During the past two decades, every one of our asset classes has had bull and bear markets," says Cuggino. "But in any market environment, we are likely to have at least some assets that are doing well."
Cuggino does not attempt to outsmart the markets by dramatically shifting his bets. Instead, he keeps the allocation for each asset within a set range. While bonds can account for from 31 percent to 38 percent of assets, gold can make up 18 percent to 22 percent of the portfolio, and growth stocks comprise 13 percent to 17 percent of the fund. The aim is to maintain broad diversification.
During the 1990s' bull market, fund results were stodgy. Recently, however, the holdings of gold and natural resources have powered the fund to top returns. In all kinds of markets, Permanent Portfolio has recorded low volatility. The fund has not suffered a losing calendar year since 1994.
Its steady results have helped the fund attract a client base that includes conservative investors and retirees who seek to preserve assets. "These people want growth, but growth is not their first concern," says Cuggino.
In recent years, Swiss bonds have been a winning holding for the fund. As the dollar has declined, the value of Swiss assets has increased for U.S. investors. Cuggino keeps 8 percent to 11 percent of the portfolio in Swiss securities. "The Swiss franc has a long history of retaining its value," says Cuggino. "The Swiss government protects its currency and doesn't run big budget deficits."
To take advantage of bull stock markets, Cuggino typically holds 30 to 50 high-quality growth shares. The stock holdings are diversified, including a broad collection of industries and stocks of all sizes. Cuggino favors leading companies that seem likely to deliver earnings growth for sustained periods. He looks for experienced management teams that have records for delivering earnings. After buying a stock, he typically holds it for three to five years. A favorite holding is Hewlett-Packard: "The company is reducing costs and taking market share away from Dell," he says.
Cuggino is avoiding big banks because of their problems with loan defaults. But he has been buying brokers and other financial shares that have fallen in the general downturn. The fund holds Charles Schwab-- "Schwab is the leader in its segment of the brokerage industry," says Cuggino. "They shouldn't be hurt much by the problems in the mortgage markets."
Permanent Portfolio owns natural resources shares along with growth companies. Holding the two groups provides diversification, says Cuggino, since the natural resources stocks sometimes thrive when growth shares are languishing. Natural resources stocks in the portfolio include Chevron and BP, integrated oil producers. "The big companies are controlling their costs and raising prices," says Cuggino. "The demand for energy is insatiable."
In his bond portfolio, Cuggino carefully avoids risk. He sticks with Treasuries and corporate bonds that have been rated A or higher by Standard & Poor's. Much of the fixed-income portfolio is in short-term positions that would not suffer much if interest rates rise. The bond holdings are designed to cushion the portfolio in stock downturns and deliver the kind of steady results that the fund's cautious shareholders have come to expect.
Stan Luxenberg (firstname.lastname@example.org) is a New York-based freelance business writer and a longtime regular contributor to Wealth Manager.