(PUB) Investing 2016

9

August 2016

Morningstar FundInvestor

still bound by the reality that applies to any type of active strategy—it’s hard to beat passive indexes after accounting for fees. To be sure, that doesn’t mean objectives-based funds completely lack merit. In fact, we recommend a number of them. But we don’t believe that investors should apply a different set of criteria when evaluating the merits of an objectives-based strategy. Exhibit 1 lists the funds that we recommend. Recommended Objectives-Based Funds in the M500 Berwyn Income BERIX and Vanguard Wellesley Income VWINX have a record of producing not only consistently above-average yield but of also doing so with lower volatility and downside risk than many of their income-oriented peers. Lower volatility helps guard against the sequence-of-return risk that affects investors drawing income from their investments. Meanwhile, BlackRock Global Allocation MDLOX and FPA Crescent FPACX both predate the idea of objectives-based investing. They rise above most other volatility-protection funds, largely because they go beyond any vague notions of “volatility” to define the concept more concretely. For both funds, that means delivering equitylike returns with lower-than- equity risk, feats that both funds have accomplished over their more-than two-decade histories. Finally, PIMCO All Asset PASDX and PIMCO All Asset All Authority PAUDX have rather lofty goals ( CPI plus 5 . 0% and CPI plus 6 . 5% , respectively) that had us debating whether these funds belonged with inflation-fighting funds. However, both funds’ market- ing pages are so imbued with inflation-hedging language, and because objectives-based funds are largely classified based on their marketing message, we ultimately decided to put them in the inflation- protection group. Both funds come out ahead of inflation, though they’re behind on their ambitious return targets. Still, we believe that Research Affiliates’ disciplined, contrarian approach remains

Exhibit 1

5-Yr Return Annlzd

5-Yr Std Dev Annlzd

Morningstar Analyst Rating

Morningstar Rating Overall

Morningstar Category

Name

Income Vanguard Wellesley Income Adm

8.47 4.69 Alloc—30% to 50% Eq 6.02 5.04 Alloc—30% to 50% Eq 6.34 5.74 Tactical Allocation 6.25 6.50 Alloc—30% to 50% Eq

QQQQQ QQQQQ QQQQQ

Œ „ ª ª

Berwyn Income

BlackRock Multi-Asset Income Instl

Principal Global Div Inc Instl

QQQQ

Target Return GMO Benchmark-Free Allocation III

3.94 6.33 World Allocation — — Multialternative

QQQ QQQ

ª

JHancock Global Absolute Ret Strats I ª

Volatility Protection BlackRock Global Allocation Instl

4.19 8.87 World Allocation 7.65 8.43 Alloc—50% to 70% Eq 3.88 9.20 Tactical Allocation

QQQQ QQQQ

Œ Œ

FPA Crescent

AQR Risk Parity I

QQQ

ª

Inflation Protection PIMCO All Asset Instl

2.93 8.60 Tactical Allocation 0.84 9.51 Tactical Allocation 0.66 9.40 Alloc—30% to 50% Eq

QQQ QQQ

Œ

PIMCO All Asset All Authority Inst Principal Diversified Real Asset Instl

ª ª

Q

Source: Morningstar, Inc. Data as of July 31, 2016.

better downside protection, which results in better risk- adjusted results. Target-return funds, also known as absolute return funds, by and large attempt to produce positive returns regardless of the market’s direction, and most have produced positive returns over long-enough measurement periods. But so has a simple blended index, which has even better returns and lower volatility than most target-return funds. Inflation-fighting funds have come out ahead of infla- tion, as measured by the Consumer Price Index, during the past decade’s mild inflationary environment. Their reliance on commodities and REIT s has pro- duced notably volatile results, especially compared with a blended index or the inflation-protected bond Morningstar Category average, and the latter two have also produced better gains during that time. It’s Hard—but Not Impossible—to Beat the Indexes A healthy number of objectives-based funds seem to accomplish their goals, but it appears the same objectives could have been met far more simply, and at a sharply reduced cost, by utilizing index-based balanced portfolios. Indeed, though the managers of these funds employed specialized asset classes, sophisticated tools, and techniques like tactical asset allocation to meet their objectives, they were

well-poised to reward long-term investors. K Contact Janet Yang at janet.yang@morningstar.com