Investors wary of market volatility might consider conservative-allocation funds as a way to ease back into stocks.
These funds contain a mix of stocks and bonds but generally invest less than half of their assets in equities. They focus instead on a mix that can include fixed-income investments, cash and commodities such as gold.
"They work well for people because they do moderate the highs and lows of the stock market, and often the bond and stock markets move in opposite directions," says Russ Kinnel, Morningstar's director of mutual fund research. "It doesn't always happen, but oftentimes there is diversification value there."
Before selecting a fund in this category, Kinnel says, it's important to understand each fund's strategy.
Many funds maintain a fairly active asset-allocation strategy, meaning management makes bets on market sectors as it sees fit. Others follow a fixed-target allocation that generally remains the same in any environment.
"Right now, active allocation seems really appealing," Kinnel says. "But it's hard to do that right, and you have to recognize that you could end up doing worse than (with) a set mix."
Here are five conservative-allocation funds with high marks from U.S. News' mutual fund ratings:
Vanguard Wellesley Income
Vanguard Wellesley Income (VWINX) has had an average annual return of 10% since its inception in 1970. Management works under tight allocation constraints. John Keogh of Wellington Management handles the fixed-income portion of the fund, which typically accounts for 60% of the portfolio, and the rest consists of what Keogh calls a fairly predictable stock allocation.On the bond side, Keogh says the fund generally sticks to investment-grade corporate bonds and other high-quality securities, including Treasurys. The fund, like many in its category, has an income bias, meaning that managers look for yield from stocks or bonds.
The average dividend yield for stocks in the Standard & Poor's 500 Index ($INX) is about 2%, while the dividend yield for the stocks in the Wellesley portfolio is 4%. Keogh says the fund's goal is to protect its clients on the downside.
"When the bond markets really like risk, as the bond markets have the past 12 months, we're probably going to underperform a little bit because we're (investing in) higher-quality (bonds), and higher-quality underperforms in that environment," Keogh says. "But in 2008, being a little higher-quality is exactly what you wanted."
The fund returned 16% in 2009, 4 percentage points lower than the category average. But it outperformed its peers in 2008, when it lost only 10%, while the average fund in the category lost about 19%. The fund is the cheapest of the five listed here, with annual fees of 0.31%.
Permanent Portfolio
Permanent Portfolio (PRPFX) has an unusual strategy forged on the premise that when any one of its asset classes is performing poorly there's a decent likelihood that the others will be appreciating in value. This approach has produced an annualized return of almost 10% over the past decade.Its current target allocations are 35% in Treasurys, 20% in gold, 15% in aggressive-growth stocks, 15% in shares of real-estate and natural-resource companies, 10% in Swiss-franc-denominated assets and 5% in gold.
The fund charges 0.84% in annual fees.
