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Can you really get it all in one mutual fund?

A leading Canadian mutual fund advisory has some reservations on balanced funds, but does find five that may be worth your while.

You can have it all: the thrills and profits of stocks, the tranquility and certainty of bonds. Step right up. You can get it all in a balanced fund.

Or can you? Is a mutual fund that offers you a “one-size-fits-all” solution really able to give you the best of both worlds? If so, how come everybody’s not in one.

One of Canada’s leading advisories on the subject, the Canadian Mutual Fund Adviser, takes a hard look at balanced funds in its latest issue. It has some reservations about the whole idea of balanced funds, but it does find some things to like. And it identifies five balanced funds that stand out from their peers.

“Before you commit to a balanced fund,” says this advisory, “be sure to understand your own investment needs and what the fund offers.”

Who should decide?

When you invest in a balanced fund, you get, in effect, a combination of a bond fund and a stock fund. “In fact, some fund companies offer balanced funds that simply invest in their own stock and bond funds,” this advisory informs us.

But here is the nub of the matter. It is certainly advisable to have fixed-income securities in your portfolio. But should a fund company decide how your portfolio should be balanced between stocks and fixed-income investments, or should you?

Among other things, “you’ll want to choose the terms-to-maturity of your various fixed-income investments to suit your needs and tolerance for risk, or volatility,” states the advisory.

It’s one thing to let a fund company decide what mix of stocks you should have — that’s the whole point of a mutual fund. But it’s quite another to let the disposition of all your assets out of your hands.

“We’ve always recommended investing the fixed-income portion of your portfolio directly in bonds, GICs and strips rather than in bond funds,” says the advisory. “That way, you retain control over the terms of your investments. What’s more, the lack of fees means your returns will likely exceed those of most income funds in today’s low interest-rate environment.”

Losing retirement income

When you do make your own decisions, the most important one is the date of the maturities of your investments. “Long-term bonds and stripped coupons may sound good if you have plenty of time to wait,” says the Canadian Mutual Fund Adviser. “But these securities can take heart-stopping swings in value as interest rates change.”

When you put your money in a bond fund, you have no control of the maturities of your investments. But surely the managers of the funds know the bond markets inside out.

Yes, but they have to anticipate those markets like everyone else. They can’t control them. In 2000 bond funds holding long-term bonds did very well. But the year before, in 1999, funds holding the longest terms lost the most money. The median fixed-income fund in Canada lost 2.7 per cent that year. “If you were drawing retirement income from one such fund,” says the advisory, “you would have had to redeem some of your investment at a loss in 1999.”

When you invest in a balanced fund, you lose one more element of control. You can’t choose what proportion of your investment goes into which assets. “What’s more,” adds the advisory, “if stock markets should fall just when you need money, by redeeming units of your balanced fund, you’ll in effect be redeeming both stock and bond funds. In other words, you’ll be selling stocks when they’re low.”

More stocks than bonds

Most balanced funds have pre-set limits on the proportion of the different assets you hold. Most will have 40 to 60 per cent in either stocks or bonds. This classifies them as neutral-balanced according to the Canadian Investment Fund Standards Committee (CIFSC).

This gives managers the flexibility to add more bonds when interest rates are high, or more stocks when equities are doing better than bonds. Despite the mediocre performance of the stocks markets, most of these managers are holding more stocks than bonds these days.

As for the bottom line, balanced funds do not do better than equity funds. But they have done better in bad markets in the past. Here are the figures: over the five years to December 31, 2007, the average Canadian equity fund returned 15.6 per cent. The average fixed income fund returned 4 per cent. The average balanced fund was in between, at 8.3 per cent.

In the two weakest market years of the past decade, 2001 and 2002, bond funds and balanced funds did better than equity funds. Canadian equity funds had a compound annual loss of 10.7 per cent, while fixed income funds had an annualized gain of 6.4 per cent. Balanced-neutral funds returned 3.3 per cent, again coming in between the two. The bond markets were stronger then than they are today.

“In effect,” concludes the advisory, “a balanced fund gives the manager license to time the market on your behalf. Trouble is, we don’t know anyone who has a long record of successfully timing the market. And we think your personal asset mix is too important to leave to an impartial portfolio manager.”

That would seem to slam the door on balanced funds. But the advisory leaves the door open a crack for some investors, and finds five funds that do a respectable job.

Making life simpler

If you really don’t like to watch your investments go up and down in a zigzag pattern, balanced funds may be for you. They don’t do spectacular things, but the absence of excitement may be just what you want. “So you may feel a balanced fund would make your life simpler,” says the advisory.

But only a few balanced funds have stood out from the pack. Five, to be specific. These are the only ones this advisory recommends.

Manulife Monthly High Income Fund looks for a steady flow of monthly income and capital growth by investing in Canadian fixed-income securities and large cap Canadian stocks. It also invests in royalty trusts and real estate investment trusts.

The fund is known as an equity-balanced fund. To earn this denomination, a fund must invest at least 70 per cent of its assets in Canadian stocks and Canadian dollar-denominated fixed-income securites. It must have between 60 and 90 per cent of its portfolio in stocks.

Right now, the manager of this fund, Mr. Alan Wicks, has about 66 per cent of its portfolio in stocks. He looks for value: that is, good stocks at attractive prices that can offer growth and income. He has 26 per cent in bonds and eight per cent in cash.

The annual compound growth rate of this fund over 10 years is a very respectable 11.7 per cent, which makes it the best of the 64 funds in this category. Its management expense ratio (MER) is 2.11 per cent.

Regular monthly income

One of these five funds fits in the neutral-balanced category. RBC Monthly Income Fund looks for as high a regular monthly income as possible. It seeks out tax-efficient distributions of dividend income, interest income and capital gains, with some modest potential for capital growth.

Its 10-year average return is 8.2 per cent, second among the 56 neutral-balanced funds that have been around for at least a decade. The fund has 51 per cent of its portfolio in bonds, 46 per cent in Canadian stocks and two per cent in cash. Many of its equities are financial stocks, led by the banks. Its MER is 1.16.

If you have a very low tolerance for risk, you may wish to consider a Canadian fixed-income balanced fund, says the advisory.

Mackenzie Sentinal Income Fund is this advisory’s choice. It invests in securities that provide a steady flow of income with reasonable safety of capital. It invests largely in Canadian fixed-income securities, which make up anywhere from 60 to 90 per cent of the portfolio.

Typically, it is invested in high-quality bonds with a credit rating of ‘BBB’ or higher. It can also invest 10 to 40 per cent of its assets in dividend-paying stocks or income trusts.

Over the past 10 years, this fund has returned an average 6.1 per cent. That makes it the best of the 20 fixed income-balanced funds that have been in existence for 10 years or more. The MER is 1.84 per cent.

Two global funds

There is also such a thing as a global-balanced fund, which, as the name implies, can bring in foreign equities, frequently from the U.S. The advisory likes two of these funds.

Dynamic Value Balanced Fund looks for interest and dividend income as well as capital appreciation by investing in equities and debt obligations. The debt comes from corporate bonds that are rated below investment grade. The levels of fixed-income and equity investments vary with the state of the markets.

Right now it has about 54 per cent of its portfolio in Canadian stocks (it must have less than 70 per cent to qualify as a global fund) and 14 per cent in foreign equities, half from the U.S. 27 per cent of the portfolio is in bonds and debentures, and six per cent in cash.

Its compound annual growth rate for 10 years is 8.6, number one among the 38 funds in the group. The MER is 2.43 per cent.

The final fund is slightly different again: this is a global-balanced-neutral fund, which means its has at least 40 but less than 60 per cent in equities.

McLean Budden Balanced Growth can also invest in other mutual funds. Its top three holdings are McLean Budden International Equity, Global Equity and American Equity Funds. They make up 30 per cent of the portfolio. Overall, 58 per cent of the fund is in equities, 30 per cent in bonds and 12 per cent in cash.

For 10 years, it has compound annual return of 6.3 per cent, first among its 21 peers. The MER is 0.95 per cent.

There are also global-fixed income balanced funds, but the advisory can’t find a single one to recommend.

The five it does recommend have in common their above-average performance and reasonable level of volatility. They all tend to perform consistently above the average in their respective categories.

“That’s what we like to see most in a balanced fund,” says the Canadian Mutual Fund Adviser. “We recommend all five as superior choices, but only if a balanced fund seems to address your investment needs.”

So if you really feel you should give up control of your investments, these are the few choices worth considering, is the advisory’s bottom line.

That’s scarcely a ringing endorsement of balanced funds. In short, the question is not really whether you can get it all in one mutual fund, but whether you can get enough to feel secure.