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Steady as she goes

Like shock absorbers, balanced funds smooth out the market ride. They aren't risk-free, though

Special to The Globe and Mail

With the financial markets navigating choppy seas of late, investors are getting a stark reminder about the critical importance of maintaining a well-diversified RRSP to help ride out the rough spots. One of the investment vehicles that can help you do this is balanced funds.

Balanced funds help investors weather market gyrations by dampening the oscillating effect they would otherwise feel when markets are shaky, says Ranga Chand, an Ottawa-based economist, author, mutual fund analyst and principal of the consulting firm Chand Carmichael & Company Ltd.

"Investors want equity-like returns, but with reduced volatility, so it's kind of a one-stop portfolio that spreads your risk while providing a decent return," agrees David Graham, vice-president of Canadian equities at CIBC Global Asset Management Inc. in Toronto. "A balanced fund mitigates both the upside and the downside."

Balanced funds typically contain a variety of assets, such as bonds, equities and cash, and are often further diversified along international lines. Managers have the flexibility to change the funds' composition in response to market conditions.

Balanced funds are not, however, an instant guarantee of positive returns, though they may mitigate overall losses when markets are declining.

"Just because you've got a balanced fund doesn't mean it doesn't have risk associated with it. Particularly when the markets are gyrating, you should not expect to have positive returns every single year," stresses Mr. Chand.

He notes that approximately 40 per cent of the nearly 850 balanced funds in Canada during calendar year 2007 posted negative returns.

The portfolio manager generally has a bit of leeway, within a certain target range, in terms of what he or she can do within the fund, notes David Salloum, a certified financial planner and portfolio manager with RBC Dominion Securities in Edmonton. For example, a manager might have 40 per cent of the balanced fund in bonds, with a target range set between 35 per cent and 50 per cent.

As an investor, when selecting a balanced fund you need to take into account such factors as your risk tolerance, time horizon and previous market experience, experts say. You also need to assess the investment philosophy and experience of the fund manager, the fund's previous performance, its fees, including the management expense ratio (MER), and the composition within the fund.

The CIBC Monthly Income Fund, for example, is a balanced fund weighted with about 62 per cent Canadian equities, 19 per cent cash, 16 per cent in Canadian bonds and 3 per cent in preferred shares. Its ratio of equities tends to be 60 to 65 per cent.

Mr. Graham acknowledges that when markets are dipping, that ratio might provide a lower return than more conservative balanced funds, which are more skewed to fixed-income instruments such as bonds.

But it will also provide a quicker upside when economic conditions improve and markets start swinging up again, because over the long run the equity market tends to outperform the bond market, he explains. Consequently the fund's ratio has "not changed a lot over the years."

The need to have a long-term outlook is echoed by other professionals who stress that balanced funds should merit consideration as part of a long-term RRSP investment strategy, rather than a knee-jerk reaction to markets when they are volatile or in a down cycle.

Investors also need to decide how much of their overall RRSP portfolio the balanced fund will comprise.

Some people might want a balanced fund to comprise all of their RRSP, "because they're not risk oriented and maybe don't know that much about the equity markets," notes Mr. Graham. Whereas "other people might say 'I want 20 per cent or 50 per cent of my portfolio to be in this balanced fund where I don't have to worry, and then I'm willing to take a little bit of risk.' It depends how they want to structure their portfolio," he says.

"If they don't really have the time or the inclination, then they could make this 100 per cent of their RRSP, and should do well over time," Mr. Graham adds.

The annual MERs also should be studied carefully, financial advisers say. They are sometimes high, though they range widely in the vicinity of about 1.25 per cent to 2.75 per cent of total assets.

The MER "comes off the top, and if you have fixed-income holdings that are [providing a return] in, say, the 4.5 to 5-per-cent range, you're giving up a chunk of that for the fee," says Mr. Salloum.

Some investors might want to build their own balanced mix of funds to avoid having to pay that fee. "You can develop your own core portfolio in terms of having, say, a good Canadian equity fund that is broadly diversified, as well as a diversified global equity fund, and a bond fund," Mr. Chand suggests.

Purchasing a small amount of an externally managed balanced fund for your RRSP portfolio - or even observing the published results of a larger well-known fund - can also serve "as a good proxy for somebody to look at how the balanced funds performed, particularly in the current market turbulence," says Warren Baldwin, the Toronto-based regional vice-president of T.E. Financial Consultants Ltd.

You can take that knowledge and use it to build your portfolio by replicating the underlying mix of the balanced fund; this would be more efficient than incurring a high-cost MER, particularly against lower-return, fixed-income investments that can create "a drag factor," Mr. Baldwin says.

Another potential drawback to balanced funds is the "yawn factor," he says.

"Balanced funds are very boring to a lot of investors who think they can be smarter than the market. It hasn't got sort of the sizzle of some of the other approaches, but it hasn't got the downside either, and you probably won't get burned."


One expert's picks: heavy-hitting Canadian balanced funds

Ranga Chand, an Ottawa-based economist, mutual fund author and principal of the consulting firm Chand Carmichael & Company Ltd., looks at the long-term track record of a balanced fund to determine its degree of success.

He believes in examining the return of funds on at least a five-year basis and looks for funds that consistently deliver above-average rates of return "relative to their peer group."

With that in mind, he has selected the five funds in the accompanying chart for a list of "heavy hitter" Canadian balanced funds. The five funds each have different asset allocations, but "over the past five years, every single one of them delivered double-digit returns. That's a key reading for me," says Mr. Chand, who notes that the funds he selected managed to weather some pretty turbulent years at the start of this decade.

"The interesting thing is that every one of these particular funds has delivered positive returns over any five-year holding period in their entire history," he adds. "That history takes into account all different types of economic cycles, including the great bear market of 2000 to 2002, as well as a brief U.S. recession in 2001, and rising and falling interest rates."

Jeff Buckstein

FundCategoryAsset allocation StocksAsset allocation BondsAsset allocation CashTotal return 2007Total return 5 yearsYear-to-date return As of Feb. 22MERInception
Fidelity Canadian Asset Allocation AEquity72%19%9%5.9%11.2%-1.3%2.41%Dec. '94
TD Monthly Income - 1Equity61%30%9%3.1%12.1%-2.7%1.41%June '98
Dynamic Power BalancedNeutral59%36%5%14.9%15.9%-0.8%2.64%July '98
CI Harbour Growth & IncomeNeutral55%12%33%3.8%10.4%-0.5%2.33%June '97
RBC Monthly IncomeNeutral47%51%2%3.2%11.1%-1.2%1.16%Aug. '97

Note: All information as of Dec. 31, 2007. All funds delivered above-average returns over each of past one, three- and five-year periods relative to their respective categories.


© 2007 The Globe and Mail. All rights reserved.

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