Issue: September/October 2005

The case for Balanced Funds

Steve Mills is Head of Portfolio Management at Sanlam Investment Management. Steve Mills is Head of Portfolio Management at Sanlam Investment Management.

A balanced fund is an investment portfolio that has a diverse asset allocation so that it invests in cash, bonds, equities and property and holds the equivalent in international assets. Within equities, the content usually represents a general type of portfolio.

Why would a retirement fund or an individual invest in a balanced fund and not in a range of specialist funds?

In a world of ever changing fortunes, complexity and uncertainty, it is extremely difficult to be in the right specialist funds at the right time. It is even more difficult to exit the funds at the right time. In other words, the average investor in most cases gets into the specialist funds after the event (near the top) and often rides the inevitable correction all the way down – ending up in tears.

The most common response from the industry is usually: “you did not understand the risk associated with this sector and should never have invested so much money in that particular specialist fund in the first place.” No problem to the marketers of these products as they then slotted everyone into, generally, three risk tolerance bands – conservative, moderate and aggressive based on the often misunderstood concept of volatility of returns. The trade off of course is the higher the risk one is willing to assume the higher the returns, in the longer run, one can look forward too. This is unfortunately is not always true as one only needs to be reminded of entering the technology sector in early 2000. You will have to have an extraordinary long time horizon to recoup your capital even in nominal terms!

The key is to understand risk and investor behaviour. Simply put, never lose money; i.e. move into a negative position. It takes very good understanding, patience and even wisdom to tolerate losses particularly if the duration of the losses is for a lengthy period.

So what is the solution to provide a one stop, low risk solid and safe outcome?

The traditional balanced fund which has been out of favour in recent years can provide a basic but reliable solution. Why should this be the case?

The first and major reason is that the balanced fund is built on the premise of diversification. This, in a nutshell, means that different asset classes behave or react differently to their basic return drivers. For example, in a recession where corporate profits are under severe pressure one would expect the value of equities to decrease. However, interest rates should be falling so bonds will be the preferred asset class as the value would increase. Cash would also be attractive as it would make, as always, positive returns. The skill in making the timing shift from one asset class to another is a very controversial subject as there has been much research into the pros and cons of whether managers can, over the long term, add value by this technique. Suffice to say that the diversification benefits far outweigh the timing debate.

The second reason for balanced funds is that within equities one is generally getting the best view of the manager across the full spectrum. This would be typical of a general equity fund. Again, diversification comes into play.

Finally, if there is an obvious big money making trend within an equity sector then it is highly unlikely that the balanced fund manger will miss out on it completely thus providing a return that is still competitive.

Can one lose money in a balanced fund over a 12 month period? The answer is yes - if equities have a serious negative year. The losses, however, will be substantially reduced because of the cash, bond and possibility property exposure. The converse is also true. In a very strong equity market, a balanced fund will under perform a pure equity fund.

In conclusion, the major tenet throughout this article has been diversification in order not to lose serious money on the downside. The logic being that investors will only be marginally less satisfied if they make a little less money on the upside. However, it is imperative to avoid, at all costs, the loss side as that is where investors react, quite rightly, the most negatively. A balanced fund should provide the one stop, all ‘weather’, solution for most investors.

We at Sanlam Investment Management believe that, given the track record of the Balanced Fund, we have all the necessary investment skills and capabilities in execution to provide the market place with a fund that is reliable, consistent and most importantly, produces above average investment returns. This might just be the sort of investment vehicle that most retirement funds and individuals are actually looking for.