(PUB) Morningstar FundInvestor

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A Tough Challenge for Allocation Funds Morningstar Research | Greg Carlson

These results underline the importance of buying an allocation fund that boasts not just stock-selection expertise, but savvy fixed-income investors as well. Gold-rated Dodge & Cox Balanced DODBX is one such fund, and it has bested nearly all of its moderate- allocation rivals during bonds’ recent swoon. True, the fund’s above-average equity stake ( 74% at the end of June) certainly helped, but fixed-income security selection was a factor as well: Dodge & Cox Income DODIX , which also earns a Gold rating and virtually mirrors the bond portfolio of Balanced, held up better than 95% of its intermediate-bond peers during this stretch. Other allocation funds that sport particularly strong fixed-income teams include PIMCO All Asset PASDX , Vanguard Wellesley Income VWINX , and Vanguard Wellington VWELX —all Gold-rated; Silver-rated Janus Balanced JABAX ; and Bronze- rated Fidelity Puritan FPURX . On the flip side, some otherwise well-regarded allo- cation funds are comanaged by fixed-income teams that have struggled, and some don’t have much fixed- income expertise behind them at all. Examples of the former include Silver-rated American Funds American Balanced ABALX , American Funds Cap- ital Income Builder CAIBX , Silver-rated American Funds Income Fund of America AMECX , and Bronze- rated American Funds Global Balanced GBLAX . The funds’ bond portfolios are managed in part by the same team that runs American Funds Bond Fund of America ABNDX , which is rated Neutral and sports a medi-ocre long-term record. Another fund that boasts excellent stock-pickers behind it, Silver-rated Oakmark Equity & Income OAKBX , doesn’t have a dedicated bond team. Consequently, the fund’s bond sleeve has long been dominated by a big stake in Treasury bonds that doesn’t change much. That stance is fine when Treasury bonds perform well, and it does reduce credit risk, but the fund may find itself well behind peers if Treasuries take it on the chin for an extended period. Struggling Amid the Rising Tide Some of the more notable allocation funds that take a tactical approach—making portfolio shifts to take advantage of anticipated market movements—have

Total Return %

p Barclays US Agg Bond TR USD p US OE Conservative Allocation

p S&P 500 TR USD

p US OE Aggressive Allocation p US OE World Allocation

p US OE Moderate Allocation

11,000

10,600

10,200

9,800

9,400

05/2013

06/2013

07/2013

08/2013

Data from May 1, 2013–Aug. 31, 2013. Measurement in USD.

The falling bond market of the past several months has left many allocation funds well behind broad equity indexes. Conservative-allocation funds, which invest 20% to 50% of their assets in stocks and typically stash much of the rest in bonds, have been hit hardest. As the yield on the 10 -year Treasury bond rose from roughly 1 . 6% on May 1 , 2013 , to 2 . 78% on Aug. 31 , 2013 , the typical conservative-allocation fund has lost 2% . Equities have risen significantly; over the same period, the S & P 500 Index has gained 3% . Allocation funds with bigger equity stakes have taken a hit, too. Moderate-allocation funds, which invest 50% to 70% of assets in stocks, also lag the S & P 500 with a paltry 0 . 1% gain. Even aggressive-allocation funds, which have fairly heavy equity exposure at 70% to 90% , have been held back by bonds’ decline: They’ve posted a median gain of 0 . 7% during the period, less than half as much as the S & P. World-allo- cation funds have suffered as well. They invest roughly half their assets, on average, in stocks and lost 2 . 6% from May 1 through Aug. 31 , while the MSCI All Country Index lost 0 . 7% .