The mutual fund world has more choices than a
Bob's Big Boy
So a number of funds have tried to make it easy to get a balanced meal in one purchase.
Asset allocation funds, balanced funds, funds of funds and, to a lesser extent, so-called all-star funds are different approaches to the same goal: an all-in-one portfolio that reduces risk by spreading your money across different kinds of mutual funds or asset types.
Keep in mind that by reducing risk, these funds also can take away some of the reward. And, in general, you'll pay additional fees to the experts who decide how to allocate your assets. But if you're too busy to keep constant watch on your portfolio, why not leave it to a professional?
Let's look at each of these types of portfolios separately.
These funds can have holdings in equities, bonds, real estate, foreign stocks, domestic stocks and precious metals, all in one portfolio. They may also use exotic instruments, such as derivatives, as hedges. With funds like these, you can throw away all those asset allocation pie charts and quit wondering how you're going to achieve a 2.8% stake in gold.
If you're really concerned about a fully diversified portfolio, this may be the way to go. You get exposure to lots of sectors and asset classes you probably wouldn't have the expertise to invest in on your own. And the portfolio manager can rebalance the fund if certain sectors or asset classes grow (or shrink) so much that the allocation gets out of whack.
But be aware that these funds also expose you to laggards. Managers will reshuffle between different asset classes, but only within a small range, so you'll always have money in underperforming areas. Does every shareholder have to have their fingers in real estate and natural resources? Probably not.
Asset allocation funds come in various flavors, from the aggressive to the conservative.
, for example, offers four varieties. The aggressive
Managed Growth fund has an 80% allotment in stocks and is designed for young investors with a long time horizon. As the portfolios get more conservative, their stock portion goes down. The least-aggressive
Managed Income has just 15% in equities.
These are not the kind of funds you buy for chart-busting return figures. Of the more than 100 self-described asset allocation funds, only two have outperformed the
index over the last three-year period.
Balanced funds are similar to asset allocation funds, but generally include just two asset classes: stocks and bonds. Depending on the target audience, fund companies will adjust the weightings of each.
With a balanced fund, managers use bonds to mitigate the volatility of stocks. As often happens, when equities take a plunge, investors flee to the relative safety of bonds. Therefore, it softens the blow of a stock downturn. But rising interest rates in the last year have sent bond prices down even when stocks have tumbled.
And because these funds include fixed-income, the equity side of the portfolio isn't usually geared for risk-takers. Take the $2 billion
T. Rowe Price Balanced fund, as an example. Among its holdings are some technology evergreens like
, but mainly it's got blue-chips like
that are steady, but not spectacular, performers.
Funds of Funds
Like asset allocation funds, these funds seek to spread risk over several asset classes by investing in mutual funds rather than directly in securities and other assets. The advantage is clear: Investors get the benefit of several managers in one investment. Plus, they get a manager of the managers who will make sure that each of the funds is still a good buy for a particular investment style.
For example, the diversified portfolio of the $75 million
Kobren Growth fund includes
Fidelity Aggressive Growth,
Marsico Growth & Income,
Artisan International and
Fidelity Select Health Care.
"These are good for someone who doesn't want to spend a lot of time researching their funds," says
analyst Frank Stanton.
But the risks of investing are the same as for the asset allocation portfolios. These funds won't keep pace with the narrow market.
You won't get the type of super-charged performance from a fund of funds as you will from picking the winners. Of course, as this recent selloff demonstrates, you won't lose your shirt when the winners take a dive, either.
The fund with the best three-year track record in the category,
Markman Aggressive Asset Allocation, returned 35% in 1999, but paled in comparison to the average technology fund's 66.7% return in that time period.
And these funds aren't cheap. On top of the normal management fees charged by the fund companies, the manager making the fund selection slaps on a fee, too. In Kobren's case, 0.95% annually. Ditto for Markman.
, as usual, has come up with a low-cost version. Its four
funds don't charge a fee other than those of the individual funds that make up the portfolio. Of course, that's not hard for Vanguard to do since the portfolios are made up solely of in-house funds.
Funds of funds deny active investors the fun of shaping their own portfolios. If you're really tempted, consider finding a fund of funds that meets your objectives and has decent returns and try to replicate that portfolio yourself over time.
All-star funds are similar to funds of funds. But rather than combining a sampling of top funds in one portfolio, sponsors of all-star funds ask big-name managers to make picks specifically for their portfolios.
The $450 million
Master's Select Equity fund, for example, has a lineup of six renowned portfolio managers, including Bill Miller of
Legg Mason Value Trust and Foster Friess of
. Each manager runs a portion of the portfolio, typically choosing from five to 15 stocks.
In theory, these managers' portions on the Master's Select Equity fund should outperform their own funds because they contain the managers' best ideas, says Craig Litman of
Litman/Gregory Fund Advisors
, which oversees the portfolio.
Of the six, only one manager failed to beat the returns of his or her primary fund in 1999, though Litman isn't saying which one.
The advantage of an all-star fund is that you have a manager keeping an eye on the stars. That was clear in March when Litman/Gregory gave the boot to long-time value diehard Robert Sanborn of
Oakmark, whose style has long underperformed both the market and his own value peers. His portion of the fund went to Miller.
These funds should be slightly more expensive than comparable funds because the sponsors have to pay a fee to the managers and take a cut for themselves. But Litman/Gregory's fund charges just 1.26% in annual expenses, which is less than the domestic stock average.
All-star funds come in a variety of styles, including international. Litman/Gregory is planning a fund that will be managed by three well-known value stock pickers. But mainly all-star funds aim to provide balance.
One Last Option
There's one more simple, cheap way to get broad diversification in a single investment: Buy a total-market index fund.
Total-market funds mirror the performance of a broad index like the
, though they invest in a representative sample of securities rather than each and every one. The point is to gain exposure to all the market has to offer.
These indexes tend to be dominated by their largest stocks, which means that performance doesn't differ significantly from smaller S&P 500 indexes.
Vanguard's Total Market Index, for example, has an annualized return of 26.6% over the past three years, trailing the S&P 500 by just 0.2%.