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Huddling for safety comes with a price

Balanced funds are a popular haven for investors seeking stability, but high fees and low interest rates can make them costly

There has never been a worse time to own balanced funds, and yet nothing is more popular in the mutual fund world right now.

Oh, those thickheaded investors? No way. Balanced funds make sense for nervous types, even if they too often demonstrate the fund industry at its most exploitative.

Here's a new rule for the uncertainty of 2010: Sometimes, less than optimal investing solutions are better than letting your emotions guide you.

Has your gut been telling you to stay out of stocks and keep your money safe in high-interest accounts, money market funds and bond funds until conditions look more stable? If you listened, then you've missed a 50-per-cent gain in the stock market since it bottomed in March, 2009.

True, the markets have essentially gone nowhere since last winter and may have some room to fall. But if you've been out of the stock market for the past 18 months or so, you missed a rally that repaired a lot of the losses in the big market crash.

That wouldn't have happened if you owned a balanced fund. Depending on the exact type, balanced funds may hold between 25 per cent and 70 per cent of their assets in bonds and the rest in stocks and cash. You are automatically investing in a diversified portfolio, in other words. You may not want to venture into the stock market by investing in an equity fund, exchange-traded fund or stocks, but balanced fund managers are doing just that with your money behind the scenes.

And what if the stock market falls? With their heavy bond holdings, balanced funds decline less than pure investments in stocks. That means nervous investors are more likely to stick with them over time and not sell prematurely.

"People are just more patient with balanced funds, generally," said Dan Hallett, director of asset management for HighView Financial Group. "Their losses technically are the same [as if they owned separate bond and equity funds], but they don't see their stocks fall by half. They see the whole thing fall by 25 per cent."

The benefit of combining stocks and bonds together into a livable mix is the most often mentioned explanation for the way in which balanced funds dominate the fund world today. The 12 months ended July 31 were typical of the high level of interest in balanced funds since the bear market of 2008-09 - balanced funds of all types posted total net new sales of $16.2-billion, according to the fund analysis firm Credo Consulting. Bond funds had net new sales of $11.2-billion, to take second place, while all equity categories had either net selling or negligible gains.

"Bear markets always trigger more interest in balanced funds," Mr. Hallett said. "I saw this in 2001-02, and it's not surprising that it's happened again."

If you're a long-term investor who needs a decent rate of return to achieve your goals, then investing in a balanced fund instead of a money market fund or even a bond fund is the better play right now.

But let's not get too cozy with balanced funds because a lot of them are machines designed to extract egregiously high fees from conservative, less-than-savvy investors. With interest rates as low as they are today, the matter of fees has never been more important.

If rates are depressed, then the same can be said of returns from the bond portion of a balanced fund. Let's use the DEX Universe Bond Index as a proxy for the entire bond market in Canada - its yield late this week was about 2.8 per cent.

A balanced fund might easily have fees that chop as much as 2.3 percentage points or more off its returns (returns are published on an after-fee basis). So now you're looking at a gain of something like 0.5 per cent from the bond portfolio of a balanced fund.

Bonds have actually been rising in price lately, which means there's potential for balanced funds to report gains on bonds that are worth more than the purchase price. That could help pump up balanced fund returns a bit in the near term.

Eventually, though, the economy will enter a strong, sustained growth phase and interest rates will rise. The capital gains that bond funds are seeing now will turn into capital losses then, and that in turn will hurt returns from bond funds.

Mr. Hallett said that if you're going to use balanced funds, fees are a key point to consider. "The larger the bond component, the larger a factor fees should be in the selection process. That's the bottom line."

Mr. Hallett suggested that do-it-yourself investors look at low-fee fund companies like Mawer Fund Investment and Leith Wheeler Investment Counsel, which offer funds directly to investors and through online brokers. For investors who have advisers, he highlighted lower-fee options like CI Signature High Income and TD Monthly Income A.

The average management expense ratio in the Canadian neutral fixed income category - that's the most popular of the six subcategories of bond funds - is 2.46 per cent. As is often the case, this number is inflated by smaller funds with high fees. But there are still lots of balanced funds with MERs above 2 per cent. Given how low interest rates are, it's hard to justify fees this high.

Investors are increasingly finding relief from high mutual fund fees in exchange-traded funds, which are index-tracking securities that trade like stocks. However, the ETF industry has largely neglected the balanced fund category.

The Horizons AlphaPro Balanced ETF (HAA-TSX) was launched a month ago, but it's basically a balanced mutual fund in an ETF wrapper. The fees are comparatively low at an estimated 1 per cent, but not as low as the 0.17 to 0.35 per cent you get with many traditional stock and bond ETFs.

The Claymore and iShares ETF families both offer products that are super-complex balanced funds with 15 or so components in some cases, including commodities, gold and high-yield bonds. These funds are more correctly viewed as wrap products - an entire portfolio in a single product - while balanced funds are a much simpler blending of stocks, bonds and cash in most cases.

It's this simplicity that helped make balanced mutual funds as popular as they are, whereas ETF wrap products have generated interest from investors than could generously be described as light. Point of trivia: Not a single share of the iShares Growth Core Portfolio Builder Fund (XGR-TSX) was traded in 12 of 19 trading days from Aug. 2 through Aug. 26.

Memo to the ETF industry: How about coming up with a straightforward minimalist, low-fee balanced fund to compete directly with the mutual fund industry in its most popular product category today by far? Just maybe we'd end up with an optimal way for investors to stop their emotions about the stock market from ruling them.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance


Best balance

Money is flying into balanced mutual funds these days, making them the top category by sales. Looking for some solid leads to start your research in the category? Here's a selection of funds highlighted by Dan Hallett, director of asset management for HighView Financial Group. Full profiles of each fund can be found on

For Investors Who Have An Adviser
MutualFundMER (%) Minimum Inv. ($)One-YearReturn (%)Five-Year Return (%)
CI Harbour Growth & Income 2.345003.63.3
"Gerry Coleman's stock-picking is the driver behind this recommendation. Also, the fund boasts competitive fees (for a load fund with an equity bias) and a conservative bent on the bond/cash component."
CI Signature High Income 1.5450019.23.9
"This is a more actively managed fund at the asset mix and security levels. Erich Bushell's calls have been right much more often than not. It's a flexible mandate with low fees and quality management."
TD Monthly Income A 1.450011.94.5
"This version is sold through advisers so it pays them standard commission rates. Still, its MER is almost in no-load territory. The bonds are mostly corporate, so this can be viewed as a more aggressive fund."
For Do-It-Yourself Investors
MutualFundMER (%) Minimum Inv. ($)One-YearReturn (%)Five-Year Return (%)
Leith Wheeler Balanced 1.185,0009.52.2
"Solid stock picking & bond management, along with low fees make this an attractive one-decision fund overall."
Mawer Canadian Balanced RSP (for registered accounts) 1.015,0008.73.4
Mawer Canadian Diversified Investment ( for non-reg. accounts) 1.025,0009.13.3
"Mawer is a terrific firm and these funds expose investors to a bit of everything at fees that just break the 1-per-cent barrier."
RBC Monthly Income 1.145008.24.6
"It's far from perfect but anybody can march into a RBC branch with almost any amount of money and access solid money management at a very competitive fee level. For non-registered accounts only."
Notes: Performance data is to July 31; the $5,000 minimum for Leith Wheeler Balanced applies to purchases through online brokers - the minimum is $25,000 if purchased directly from the company.
Source: Dan Hallett;

© 2007 The Globe and Mail. All rights reserved.

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