Hybrid Funds Promise Stabler Returns
Investment companies tout `balanced' and `asset allocation' funds for those times when market is all ups and downs
SAN DIEGO — WITH stock and bond markets plummeting one day and surging the next, many small-time investors are scratching their heads. Should they reduce their exposure to stocks or bonds, or hang in there and ride out the rough times?
One way to try to do a little of both without mental anguish is to invest in hybrid mutual funds that blend stocks, bonds, and cash in one investment package.
Among funds where managers can move flexibly between stocks and bonds, a variety called asset-allocation funds has grown increasingly popular over the last couple of years. Asset allocation involves trying to find the optimum mix of different types of investments, often using statistical formulas to assess current markets. In another class of hybrid fund, balanced funds, managers rarely shift from a 60-40 blend of stocks and bonds. Together, balanced funds and flexible-blend funds account for about 12 percent of the $770 billion that Americans have invested in equity-holding mutual funds.
``Both of these categories have been significantly less volatile than the stock market,'' says Amy Arnott, an analyst with Morningstar Inc., a Chicago company that rates funds. But both categories have failed to beat Standard & Poor's corporation's widely used index of 500 stocks, suggesting that long-term investors who can afford to endure short-term fluctuation in their investments would do better with heavier exposure to stocks.
With $32 billion invested in them, asset-allocation funds lag behind balanced funds, which have $58 billion in assets. But the former group has come on strong, going from only four funds 10 years ago to 75 today. Balanced funds have grown more in line with the rest of the industry, with the number quadrupling to more than 100 in the last decade.
Boston-based Fidelity Investments, the nation's largest fund company, saw its Asset Manager fund and its balanced fund both roughly triple in assets last year, to $9 billion and $4.7 billion, respectively.
The asset-allocation idea is ``finally getting the due it deserves,'' says Jeremy Duffield, a senior vice president at the Vanguard family of mutual funds, in Philadelphia. Like Fidelity's balanced and asset-allocation funds, Vanguard's hybrid funds in those categories have roughly matched the return of the S&P 500 despite their diversified approach.
Flexible funds are for ``anybody who wants a diversified asset pool with somebody calling the shots,'' Mr. Duffield says. When markets are fluctuating, ``that's where many individual investors get into trouble. They let their emotions rule their decisions.''
Instead, Vanguard's asset-allocation fund is guided by a ``decision framework'' created by William Fouse, whose San Francisco company Mellon Capital Management runs the Vanguard fund. Mr. Fouse says his model, which looks at the expected risk-adjusted returns for different investments, will do a far better job than an individual investor.
The Vanguard fund, now with $1 billion in assets, fell much less than the overall stock market in a 1990 drop. Though the fund did not exist until 1988, Fouse says his model would have had most assets out of stocks prior to the crashes of 1973 and 1987, even though typically 60 percent of the fund's assets are in stocks.
This year, the Vanguard fund and most peers have been hit by a simultaneous drop in bonds and stocks. The Vanguard fund is down more than 3.4 percent so far.
The average balanced fund is down 2.4 percent this year, according to Lipper Analytical Services in New York. That's only 1 percentage point better than the average all-stock growth fund. Company president A. Michael Lipper notes that in the average declining market, balanced funds have ranked 7th out of 33 types of mutual funds, while in up markets they ranked 24th. He warns that since 1981, the stock and bond markets have tended to move in the same direction, so investors shouldn't expect ``directional diversification'' from hybrid funds.
While some asset-allocation funds did move heavily into cash late last year when both the bond and stock markets began to look risky, most fund managers are taking a longer-term approach that emphasizes maximizing returns rather than reducing risk. The average asset-allocation fund currently has only about 15 percent of its portfolio in cash.
A few years ago, asset-allocation funds ``were marketed as sort of the perfect fund for every market. Those expectations turned out to be too high,'' says Ms. Arnott of Morningstar. Now they are advertised more as ``one-stop shopping'' for a range of investment classes.
Mr. Lipper says he would recommend balanced funds over asset-allocation ones, because the constant 60-40 balance leaves less room for managers to make poorly timed moves between markets. More-sophisticated investors, he adds, would be better off establishing their own optimum mix of stocks and bonds by buying into various securities or mutual funds.
Even after deciding a hybrid fund would match their goals, investors should consider carefully which fund to buy. Like mutual funds in general, hybrid funds come in many flavors.
Vanguard's asset-allocation fund makes no effort to pick specific stocks, buying into the whole S&P 500 index. This means the fund will not post the stellar returns some funds see in a given year, but it also will not fail to beat the index.
Here in San Diego, the Nicholas-Applegate family of funds offers a Balanced Growth Portfolio that chooses mostly ``mid-cap'' stocks. These mid-size firms are often growing faster than large-capitalization companies, but are more stable than small-cap firms.
Merrill Lynch's Global Allocation fund has performed well with an emphasis on allocating assets among markets worldwide.
Many hybrid funds diversified into more foreign holdings last year, Arnott notes. Fidelity's Asset Manager fund, for example, recently held almost half its assets in foreign securities (50 percent is that fund's contractual limit). The fund manager has since reduced overseas holdings to around 40 percent.
Fidelity offers two other versions of its Asset Manager fund, one aiming for high current income and another for long-term capital growth. All three ``have been enormously popular in 1993 and the beginning of this year,'' says Tracey Curvey of Fidelity.
``They're kind of all-weather funds'' that can serve a useful role in the portfolios of all types of investors, she says.
* This article launches a periodic look at personal finance issues in the Monitor.