Investor's Business Daily, July 5th, 2007
An ounce of prevention is worth a pound of cure for both one's body and portfolio.
Thus, managers of many asset allocation funds say they dealt with the bond volatility well before yields spiked in May and June. Their portfolios are structured in such a way that they don't have to react.
Asset allocation funds come in three varieties: life cycle (also called target-date), lifestyle and active.
In life-cycle funds, an investor chooses a fund with date, usually near retirement. The managers invest in equities and fixed income securities. They shift assets increasing toward fixed income as time goes on.
Lifestyle funds are allocated according to risk level. An investor will usually pick a conservative, moderate or aggressive fund. Assets are allocated to keep the risk levels constant over time.
In active asset allocation funds, shifts in assets are based on where managers see the best opportunities.
The funds' structure doesn't always provide complete protection from market hiccups in the short run. In the past month going into July 5, Target-date 2030+ funds tracked by Morningstar were down 0.17%, while moderate allocation funds were down 0.32%. The average U.S. diversified stock fund was down 0.24%.
For the year to date, Target-date 2030+ funds were up 9.48%. Moderate allocation funds were up 6.53% and U.S. diversified stock funds 10.34%.
Target-date 2000-14 funds fell 0.32% the past month but were up 4.58% for they year. Conservative allocation funds slipped 0.39% the past month but were up 3.82% for the year.
Jonathan Shelon, co-portfolio manager of Fidelity's Freedom Funds, says these funds of funds are designed to weather bond market movement by holding securities that are not correlated to either bonds or equities.
Inflation-Hedging Pieces
So the structure of the fund has a cushion built in. One good way to do that, he says, is to diversify with inflation-hedging components such as TIPS or real estate funds, which aren't correlated with the markets as closely, and even leveraged loans.
Fidelity Advisor Freedom 2010 FACFX will have more of those instruments because hedging is more important to investors who expect to be paid sooner. (At the end of the first quarter, 2.2% of the fund's assets were "other" -- neither cash nor securities).
The 2050 fund, by contrast, is 90% equity, so bond market movement matters less.
The current environment is something of a test, Shelon adds.
The first Fidelity lifecycle funds were rolled out in the early 1990s, a time of historically low interest rates, a rising market and inflation expectations that were below normal. "We've been managing for 10 years and haven't seen an inflationary environment yet," Shelon said.
Jeff Knight, managing director at Putnam Investments, runs several risk-based portfolios. He says the spike in yields and drop in prices signaled a big change in a bond market that up to that point had been relatively quiescent.
With the yield curve returning to a more normal shape, yields have been pushed higher for longer-dated debt.
That means larger companies tend be favored in the market over the smaller, because larger companies are more likely to be able to pay long-term obligations. Investors also tend to move from high-yield and corporates into T-Bills and munis, which are less risky.
That's what Knight's fund is doing. "Even in a high-risk fund, the priority is to stay out of trouble," he said. Knight tries to structure his funds in a way that reduces the need for major changes, but that it isn't always possible.
Structural Defense
John Hancock Funds uses fund structure to address major market movements, says Bob Boyda, senior vice president.
John Hancock's lifestyle offerings are funds of funds. So Boyda says he has to watch what different managers do in a given rate environment. "You have to pay attention," he said.
John Hancock offers seven lifestyle portfolios, ranging from conservative to aggressive.
In the Lifestyle Conservative Portfolio JALRX, 4% of the assets are in high-yield bonds and another 11% is in government securities.
Those two asset classes are managed by Western Asset Management. WAMCO generates absolute return by picking a bond mix that offsets losses when prices fall with an equivalent (or better) yield gain.
Boyda says the various portfolios also use multisector bond funds. They allow the manager to move between different classes of bonds to pick up better performance in a changing market. "There are more places to hide with multisector bond funds," he said.
