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Mutual Funds for Cautious Investors

NEW YORK ( TheStreet) -- With markets heading for the summer doldrums, this could be a time to consider cautious balanced funds, which hold mixes of stocks and bonds. Balanced managers aim to provide mild-mannered vehicles that can deliver some gains in bull markets and avoid the worst losses in downturns. The steady approach has worked admirably in the erratic markets of the past decade. During the last 10 years, the balanced funds in Morningstar's moderate allocation category returned 7.7% annually, outdoing the S&P 500 slightly while taking less risk.

Classic funds in the moderate allocation category hold about 60% of assets in blue-chip stocks and most of the rest in high-quality bonds. But a few managers spice up the fixed-income recipe by including convertibles, preferred shares or other instruments. These wide-ranging portfolios could be sound choices at a time when interest rates have been climbing. When rates rise, bond prices tend to sink. But convertibles can be more resilient, sometimes gaining when most bonds are falling.

Like bonds, convertibles make fixed interest payments. Convertibles currently yield 2.6% on average. The interest payments tend to prop up values during periods when investors become nervous. When stocks are rising, convertibles can be converted into common shares. As a result, convertibles can deliver some of the upside of stocks.

Solid balanced mutual funds that hold convertible stakes include Invesco Equity and Income (ACEIX), Northern Income Equity (NOIEX), and Value Line Income & Growth (VALIX). All three funds outdid the S&P 500 by a wide margin during the downturn of 2008. In the rally of the past four years, the balanced portfolios delivered decent results.

Northern Income Equity has about two-thirds of its assets in stocks and most of the rest in convertibles. The convertibles proved their resiliency recently. With interest rates rising during the past month, bond prices dropped, and the average moderate allocation fund sank into the red. But Northern returned 0.8%. During the past 10 years, the fund returned 8.4% annually, topping 96% of peers.


Because the fund aims to deliver income, portfolio manager Jackie Benson most often buys dividend-paying stocks. Benson likes unloved companies that seem poised to exceed market expectations. A holding is the common stock of Xerox (XRX), the copier company that has struggled to expand in outsourcing services. The stock yields 2.6% and has a modest price-to-earnings ratio of 9. "The expectations for the stock are low, but the company is turning around and delivering cash flow," Benson says.

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