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May 3, 2001

Many balanced funds failed meltdown test
Half lost money, and a handful did very poorly

Jonathan Chevreau
Financial Post

Investors overweight aggressive equities the past year should have learned a costly lesson about the benefits of diversification and asset allocation. This raises two questions for investors fortunate enough to engage advisors who put them into a traditional "balanced" mix of stocks, bonds, cash or other asset classes (such as gold, real estate, hedge funds).

How did balanced and asset allocation funds, or middle-of-the-road wrap programs, do over the past volatile year? And second, should this market turbulence continue indefinitely, how much protection are balanced portfolios likely to provide those who commit capital to them?

Looking back, the best balanced funds did rather well the past year. The top three Canadian balanced funds, all from Mackenzie Financial Corp., returned 22% to 24%, according to Morningstar Canada. Trimark Income Growth -- a fund I included in several columns about the "Rip Van Winkle" two-fund portfolio -- returned 20%.

But more than half the 400 domestic balanced funds lost money for the year ended March 31, 2001. True, most of the laggard balanced funds lost only a bit -- a 5% or 6% loss would look good to someone who lost 60% on the Nasdaq.

Still, a handful of supposedly balanced funds managed to do very poorly, such as the 17% loss of CI Balanced or Caldwell Balanced. The worst of all was Cambridge Balanced, which lost 52%.

Similarly, the 86 tactical asset allocation funds ranged from a high of a 29.5% gain to a loss of 16%. Included in the losers is a 14% loss by Altamira Growth & Income and Dynamic Fund of Funds.

Finally, the global balanced/ asset allocation funds ranged from the 16% gain of Mackenzie Cundill Global Balanced to a minus 32% for Caldwell International.

What does this tell us about the likelihood of asset allocation preserving capital going forward? First, there's a wide variability among balanced and asset allocation funds. Despite the stability of having 40% to 60% bonds or cash, some managers still manage to make lots of money or lose it with the equity portion of their funds.

If I were a conservative investor in a balanced fund, I'd be pretty upset if I'd lost the kind of money some of the losing balanced funds lost the past year. It's one thing for a science and technology fund you knew was risky to lose that kind of money. If your advisor was on the ball, he or she would have limited your total portfolio exposure to 5%, or at most 10%, in such a fund. But for a core balanced fund -- which might make up the entire net worth of an investor -- to lose such amounts of money is outrageous. As with all investment funds, you should check the actual asset mix used in your fund and the individual stock holdings to make sure it matches your personal risk profile.

If you're not in funds but in managed money (including wrap accounts), a similar approach is advisable. Hopefully these are run like traditional pension funds and the damage, if any, would be slight. For example, the middle of the seven portfolios at Opus2Direct.com was down 3.4% for the 12 months ended March 31, 2001, but up 5.3% since inception on Oct. 1, 1999.

Finally, if you and your broker do asset allocation together, you might want to ensure that your portfolio isn't a tad overweight on the equity side. During the late, lamented bull market, the tilt was definitely to the equity side, which tends to pay advisors best. Even in this bear market, I've heard from advisors working inside some of the major U.S. "name" brokerages that the compensation grid has been rejigged to further reward equity-heavy fee-based managed money, and discourages payouts on bond sales. Fund consumer advocate Joe Killoran warns that many unknowing investors uneducated about portfolio construction have been sold on portfolios overweighted in equities because of lack of transparency of advisor trailer fee commissions on mutual funds.

"Advisors earn higher trailer fees selling equity funds than they do bond funds," Killoran, a former broker, says. "Full-service advisors always get their clients into short-term ladders with strip coupons because they want a steady stream of rollovers at another 5% to obscene 10%-plus hidden commissions." At his Web site (www.investorism.com), Killoran describes a conservative actuarial asset mix chart, which suggests fairly high fixed-income weightings the closer one gets to retirement.
Thus, someone less than five years from retiring would have 70% bonds and cash and 30% growth, while at the other extreme someone 20 years away from retiring might have just 25% in bonds and cash.

Any departures from those norms might be characterized as market timing. Some market bears, such as Richard Russell, are currently 100% in cash (as reported in the mid-April issue of Barron's). Others are convinced the bottom is in the stock market and are advocating a return to 100% invested portfolios. The danger of swinging for the fences is striking out. I'd prefer a consistent double and so hedge my bets with an equal split of stocks and bonds.

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