Time to Mix It Up

A fund manager cautions against a buy-and-hold strategy for the stock market.
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Diversification is always a good thing. But Jeff Knight, a portfolio manager with the $2 billion (PAEAX) - Get Report Putnam Asset Allocation Growth Portfolio, says it's more important now than ever.

Although stocks have had a pretty good run this year, Knight says the market is likely to perform in a "modest, positive way" going forward. That means "the '90s strategy of 'buy and hold the stock market and wait for it to go up' will be a less rewarding way to make money."

Knight says the portfolio, which was launched in 1994, is designed "to build a better strategy than simply an all-stock strategy." He's been involved with the fund in some form since the get-go.

Knight and a team of 13 others who manage the fund spread investments across 10 asset classes: U.S. large-cap growth, U.S. large-cap value, U.S. mid- and small-cap growth, U.S. mid- and small-cap value, international developed equity, international emerging-market equity, U.S. investment grade bonds, U.S. high-yield bonds, international government bonds and money markets.

By looking across all of these asset classes, Knight says, "We take advantage of a wider opportunity set and the mathematics of diversification."

The fund's A shares are up 13.3% for the year to date, have returned an average 13.8% over the past three years and 9.8% over the past five years, according to Morningstar. That represents a pickup of 0.5 percentage point vs. the

S&P 500

year to date, 2.2 points over the past three years, and 3.63 over a five-year period.

Putnam measures the fund's performance against a blended benchmark that is made up 60% of the Russell 3000 index, 15% Morgan Stanley Capital International EAFA index, 5% Morgan Stanley Emerging Markets Free Index, 15% the Lehman Aggregate bond index and 5% the JP Morgan High Yield index. According to Knight, the fund also has outperformed the benchmark for the year to date and as well as for the past one, three and five years.

With a $500 minimum investment, the fund is accessible to retail investors. The A shares have an expense ratio of 1.25%, according to Morningstar.

The fund was named a Lipper leader for consistent return and total return for both the three- and five-year periods.

The fund managers take both micro and macro factors into consideration. Knight says there will be periods in which stock-picking will be more successful, and times when getting allocations correct across asset classes, countries and sectors will be more important.

"The stock-selection has been adding the most value this year," having contributed 190 basis points of outperformance vs. the fund's benchmark, Knight says. However, "the macro stuff is working as well," adding about 100 basis points of excess return year to date.

The fund managers also use quantitative research as part of their stock-election strategy, looking at factors such as relative valuation, profitability, operating efficiency and earnings quality.

So what does the portfolio look like?

Currently, it has about an 80% allocation to stocks, 16% to fixed income and 4% in cash. In the equity segment, the fund continues to overweight non-U.S. stock markets, especially Japan, Continental Europe and Australia. It's currently overweight in these areas by 10 percentage points combined. The fund is also overweight emerging market equities by about 3 percentage points.

French banking group

Societe Generale

is the fund's third-largest holding, according to Morningstar.

For its U.S. equity allocation, Knight says the fund is moving more toward large-cap stocks in an intermediate time horizon. The reason, he says, is that investors haven't embraced the idea that profits at these companies are booming. "As skepticism gets relaxed, there will be shift," and their stock prices should rise, he says.

U.S. large-caps

Exxon Mobil

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,

Citigroup

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,

Microsoft

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and

Hewlett-Packard

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round out the fund's top five holdings.

The fund's allocation to bonds is somewhat lower than usual, and its allocation to cash somewhat higher. "We believe the bond market has priced in a benign-to-friendly

Fed

for next year," he says.