Stocks + Bonds Make for a Smoother Ride

Stocks & Bonds

Stocks + Bonds Make for a Smoother Ride

These balanced funds have beaten most stock-only funds over the past decade.

If the market's wild swings have left you a little queasy, you might be wise to add a stabilizer to your portfolio: a balanced fund. Balanced funds keep a stash of bonds on hand at all times to serve as ballast for their stock holdings.

The result is narrower performance swings. Over the past ten years, the average balanced fund has produced one-third less volatility than Standard & Poor's 500-stock index.

And thanks mainly to two stock-market crashes over the period, their returns have been better, on average, than the S&P 500's. A $10,000 investment ten years ago in the typical balanced fund would have grown to $12,300 by September 4. But $10,000 invested in the S&P 500 would have shrunk to $9,200.

Another benefit of balance: Because most balanced funds stick close to a set asset mix -- investing 60% in stocks and 40% in bonds is a typical allocation -- managers must pare stock holdings in strong markets and buy more stocks when the market falls. In other words, the process of buying low and selling high is built into the DNA of balanced funds.


In the world of balanced funds, Vanguard Wellington (symbol VWELX) is an institution. The 80-year-old fund -- founded just months before the 1929 stock-market crash -- is one of the oldest mutual funds in existence. And with $43 billion in assets, it is one of the largest balanced funds.

But neither age nor girth has hampered its steady, peer-beating returns. Over the past ten years through September 4, the fund returned 5.2% annualized, topping similar funds by three percentage points per year, on average. And Wellington has been a model of restraint in hard times; the fund nearly broke even during the 2000-02 bear market, losing just 0.8%. Its 36% loss during the recent debacle stacks up well against its peers' average decline of 41%, and even better against the 55% loss of the S&P 500. Hand partial credit for those returns to the fund's minuscule expense ratio of 0.35% per year.

For Wellington, size does matter. Its managers won't even consider a stock unless it has a market capitalization of at least $8 billion -- any smaller than that and the fund couldn't build a meaningful position in the stock without significantly affecting its share price. Ed Bousa, who picks stocks for Wellington, says an ideal holding is a company that is gaining market share, has a decent balance sheet and pays a respectable dividend. "We're trying to identify companies that will be winners in these cash-constrained times," he says.

John Keogh, who manages the bond side of the portfolio, says his job is to provide a buffer in bad stock markets. But that doesn't mean he just sits on a pile of Treasuries, which account for only 2% of the fund's assets. He's moved most of the fund's bond stake into high- and medium-quality corporate issues, which he says offer better opportunities.


Not many funds offer the broad diversification of T. Rowe Price Personal Strategy Balanced (TRPBX). It invests in large- and small-capitalization stocks, both domestic and foreign, and in a range of debt instruments, including Treasuries, foreign issues and junk bonds. That approach has resulted in a portfolio that recently held some 672 stocks and 558 bonds. And for all that diversification, the fund charges a reasonable annual fee of 0.76%.

Personal Strategy Balanced operates like a fund of funds, says lead manager Ned Notzon. Once a month, T. Rowe Price's allocation committee meets to consider whether there are any beaten-down areas the fund should stock up on, or whether the fund should trim any asset classes. "We always balance back to take profits off the table when a position appreciates significantly," Notzon says. "You can't count on things continuing to march up all the time."

The team targets how much money should be stashed in, say, large domestic stocks or high-yield debt. Then, in order to reach those targets, Notzon invests in baskets of stocks and bonds that mimic the holdings of existing T. Rowe Price funds. Right now the fund has more money in stocks than usual, with 50% invested in U.S. companies and 15% in foreign issues.

The fund suffered along with everything else during the bear market, losing 41%. Over its history, it has lagged the S&P 500 moderately in good times and beaten it handily in bad times, as a good balanced fund should. Over the past ten years, it returned 4.3% annualized.


In contrast to the T. Rowe Price fund's impressive diversification, Oakmark Equity & Income I (OAKBX) shows how far simplicity and focus will go. At last report, the fund held just 41 stocks, balanced by a load of Treasuries. Over the past ten years it returned 9.2% annualized, beating 99% of similar funds. The stake in Treasuries helped limit losses to 27% during the 2007-09 bear market.

Managers Clyde Mc-Gregor and Ed Studzinski pick from a list of approved stocks that Oakmark's team of analysts and managers develop collaboratively. "We're looking for companies that create value over time, where managers treat shareholders as partners," McGregor says. The pair prefer to buy stocks at deep discounts to what they think a company is worth. "We like stocks selling for 60 cents on the dollar," says McGregor.

He says the fund represents his largest personal investment. "We invest as though the portfolio represents our mothers' money," says McGregor.

If Mairs & Power Balanced (MAPOX) had a motto, it might be "Buy what you know, and hold it forever." Bill Frels, who has managed or co-managed the fund since 1992, focuses on companies in the Midwest (Mairs & Power is based in Minnesota) and typically holds stocks for ten years. "We have a pretty intensive process of getting to know a company and making on-site visits," he says. The team looks for companies that can sustain an above-average rate of growth over three to five years, and "we try to buy them at a good price," he says.


That's easier said than done, but Frels has the record to back up his words. During his tenure the fund has gained 8.9% annualized, beating its rivals by an average of nearly three percentage points per year. The fund is currently heavy on health-care and financial stocks, and medium-quality corporate bonds.

Bolder flavors. To call Steve Romick's FPA Crescent (FPACX) a balanced fund is a bit of a stretch. Yes, he owns a mix of stocks and bonds, but he's not doctrinaire about the allocations. Romick takes a go-anywhere approach: He looks for the best opportunities among secured and unsecured debt, convertible securities and plain old stocks. "We look for mispricings within the stock-and-bond universe, across companies and industries," says Romick.

He also has the leeway to let cash build when he doesn't see many opportunities. He'd built a cash hoard of about 40% heading into the bear market. That proved to be an effective buffer against losses during the market's decline, as the fund shed just 28%. The fund's small short positions (of stocks that Romick bet would fall in price) also boosted returns.

Romick says the fund's aim is to generate stock-like returns with less volatility. He has done that and more: Over the past ten years, the fund gained 9.1% annualized, compared with the S&P 500's annualized loss of 2.9%, and it has done so with about one-fourth less volatility than the market.

Investors looking for a more international approach to balanced investing may be disappointed by the lack of inexpensive options. Fortunately, the one no-load balanced fund that can truly claim to take a global approach, Fidelity Global Balanced (FGBLX), is a fine choice. Its 5.3% annualized return over the past ten years falls right around the middle of the pack.

Managers Ruben Calderon and Geoff Stein make the big calls about the portfolio's allocations, and five specialist managers divvy up the stock and bond picking. At last report, 32% of assets -- or more than half the fund's stock exposure -- was invested in foreign shares, with a heavy bias toward developed markets, such as the U.K. and Japan. And 29% of assets was recently invested in foreign debt (compared with 10% in domestic bonds). The fund's significant foreign holdings should give comfort to those with a falling-dollar phobia.