Funds That Allocate Your Assets

With Treasury bond yields at 40-year lows, many market pundits think the chance of a bond sell-off is rising by the day, while stocks appear to be gaining strength. Market strategists and money managers predict that equities will wrap up the year with gains of 7% to 8%, likely beating bonds. Recent stock market rallies, though, have been short-lived, reflecting fears of more damage from the struggling economy, the aftermath of the war in Iraq, and the possibility of new terrorist attacks. Stuck between a rock and a hard place, many investors cling to Treasuries as the option that seems to carry the least risk. "It's probably the right time to be thinking about rebalancing, given that stocks are down about 50% from their peak," says Evan Grace, market strategist at State Street Research. "Our view is that stocks will outperform bonds for the first time in four years this year -- but since the magnitude of outperformance won't be very great, it will be tough psychologically for investors to leave one asset class that has done so well for another that might do only slightly better." NEW ENTRANTS. Says Duncan Richardson, chief investment officer at Eaton Vance: "While there's still some bubble trouble showing up in some corporate balance sheets, investors who don't move out of Treasuries to some extent are running the risk that their portfolios will underperform." Here's a way to solve the rebalancing dilemma: asset-allocation funds. Fund families market them as a core holding to try to capture as much of an investor's assets as possible. Asset-allocation funds relieve investors and their advisers of making sense of the volatile moves in both stock and bond markets. Several have been launched recently. In March, Columbia Management Group created the Columbia Thermostat Fund, which is marketed to clients disillusioned by the bear market and anxious to take the psychology out of investing. In late March, Gabelli Funds and Ned Davis Research launched the Ned Davis Research Asset Allocation Fund, which, in the words of Mario Gabelli, will offer investors "one-stop asset diversification, plus quantitative controls on overall portfolio risk." ONE STEP FURTHER. These funds join more than a dozen other offerings tracked by Standard & Poor's FundAdvisor, including Fidelity Advisor Asset Allocation/A (FLOAX), PIMCO Funds: Asset Allocation/A (PALAX), Nations Asset Allocation/Inv A (PHAAX), Vanguard Asset Allocation/Inv (VAAPX), and Liberty Asset Allocation Fund/A (LAAAX). All of these portfolios use quantitative models to determine how much of the fund's assets should go into stocks, bonds, and cash. Where balanced funds stop with that allocation decision, however, the asset-allocation funds go one step further. Managers use additional models to determine how much of the stock allocation should go to growth or value, and how much to small-, mid-, or large-cap stocks. In the bond portion of the portfolios, holdings go beyond Treasuries to include investment-grade corporate bonds, junk bonds, and emerging-markets issues. Because these models vary widely -- and lead to very different returns -- it's important to understand how they work and what results they can produce. There are numerous examples of poorly timed market moves dictated by the quantitative models. For instance, Vanguard's fund was caught with hefty stock exposure during early 2001, denting its short-term performance. And while the ING UBS Tact Asset Allocation Portfolio/Adv (IUAAX) dropped 25.9% for the one-year period ended Mar. 31 (thanks to what analysts call a heavier allocation to stocks than its peers had), PIMCO Asset Allocation Fund declined a more modest 14.1% over that period. LONG-TERM TIMELINES. These funds aren't right for everyone. Unlike a balanced fund, which keeps its allocation profile fairly fixed, allocation funds can move in or out of stocks entirely, changing the riskiness of the portfolio. "It's hard to produce a one-size-fits-all asset-allocation product," says Richardson. "The danger of trying to deliver this allocation service is that you try to appeal to everyone and do no one a good service. You don't want someone buying a fund when it's heavily in bonds being miserable and taking losses they can't afford when it ends up with 80% in equities." Another type of asset-allocation fund is the "timeline" fund. Such funds have a date included in the name, such as the Scudder Target 2012 Fund (KRFCX) and the American Century Target Maturity 2025/Inv (BTTRX). As the retirement date of the fund draws near, the fund manager re-balances the fund to become more conservative. Initially, these were bond funds, but they now include asset-allocation funds-of-funds, such as the Fidelity Freedom family -- including Fidelity Freedom 2020 (FFFDX) and Fidelity Freedom 2030 (FFFEX) -- which invest in various Fidelity funds. "For a younger investor, the idea is that you've got a longer time horizon and can handle more volatility right now," explains Grace. "These are really only appropriate when someone has a high degree of certainty that they won't need their capital until that target date." Regardless of whether the structure is an asset-allocation fund or a timeline fund, investors should be prepared for results that won't keep pace with a raging bull market in either stocks or bonds. "These are very sophisticated ways to manage risk, with something for everyone in them," McKay says. "Now that people have realized they likely won't make their fortune by investing in a couple of hot stocks, there's more focus on the advantage of diversification in general and these products in particular.