How times have changed. A year and a half ago, the markets were flying high, thanks to a thriving global economy, easy access to credit and robust mergers and acquisitions activity. It would have been silly to suggest that balanced funds were risky prospects, especially as most abide by prudent asset-allocation strategies and have endured a lot less volatility than their all-equities cousins.

Fast-forward to the present. Markets around the globe are drowning in a maelstrom of unprecedented events, including large-scale bank meltdowns and massive deleveraging. Balanced funds have not gone unscathed. Almost all ofMorningstar Canada’s domestic and global balanced fund indices have fallen by double digits this year.

Although one balanced fund’s recent performance looks similar to that of the next, all balanced funds are not created equal. Take, for example, Mackenzie Cundill Global Balanced Fund, sponsored by Toronto-based Mackenzie Financial Corp.; and CI Signature High Income Fund, a Morningstar fund analyst pick sponsored by Toronto-based CI Investments Inc. Both are global neutral balanced funds, but their investment strategies and portfolio characteristics differ markedly from one another.

The CI fund’s unconstrained man-date is a perfect match for lead manager Eric Bushell. Abhorring the idea of conforming to any one investment style, Bushell and his team employ a blend of strategies with the objective of producing strong, risk-adjusted returns over the long haul.

Bushell also has no qualms about using top-down analysis to determine the CI fund’s asset mix. “For example,” says Morningstar Canada senior analyst Philip Lee, “in a move to protect capital, the managers raised cash levels in mid-2007 and again in early 2008 over concerns about equity valuations and mispricing of credit risk. These moves paid off as credit and economic fears gripped the equities and bond markets, sapping their values.”

The lead manager of the Mac-kenzie fund is David Tiley, a bottom-up investor and a staunch disciple of the deep-value philosophy. He scours the market for stocks trading at low valuations, then does a thorough analysis of those companies’ balance sheets. Ultimately, Tiley’s goal is to buy businesses trading at steep discounts to their estimated worth and sell them when they reach their intrinsic value.

So, instead of relying on ma-cro-economic indicators, the Mac-kenzie fund’s asset mix decision is driven largely by the availability of attractive investments in equities markets. As stocks became cheaper recently, Tiley responded by using the fund’s cash hoard to scoop up shares in downtrodden names such as computer maker Dell Inc. and pharmaceutical company Pfizer Inc. As a result, the Mackenzie fund’s cash levels have dropped considerably over the past year, falling to 14.5% from 33%.

Notable exposures to resources names and income trusts have helped the CI fund produce first-quartile returns for the five years ended Oct. 31. Conversely, the Mackenzie fund’s longer-term numbers have been bumped into the fund category’s bottom quartile, mainly because of its formerly hefty cash stake, which created a drag on performance during the latest multi-year rally.

The CI fund wins out over recent periods, too. Although it trails the category median by 1.6 percentage points, its one-year loss of 18.2% compares favourably to the Mackenzie fund, which is down by 27.3%. Contributing to the Mackenzie fund’s underperformance has been the sharp declines experienced in its top positions, German telecom company Deutsche Telekom AG and Italian broadcast giant Mediaset.

The CI fund also gets the nod for the breadth of its investment team. Bushell has quietly assembled a team of experts specializing in commodities, fixed-income securities and equities, which allows the fund to invest in a wide spectrum of asset classes and gives it a distinct advantage over its category peers.

On the other hand, the Mac-kenzie fund’s team are stock-pickers at heart. Although co-manager Wade Burton has experience investing in distressed debt, the team doesn’t have a dedicated fixed-income specialist on board.

That key difference is reflected in the portfolios’ asset mix. Over the past several years, the CI fund has had exposure to stocks, bonds, income trusts, commodities and high-yield debt. In recent periods, the fund has been selectively buying the highest rated (BB) non-investment-grade bonds and specifically avoiding B- and CCC-rated issues. Of course, with high-yield bonds representing 34% of assets under management, the CI fund will probably take a hit if credit spreads widen further or if default rates rise.

@page_break@By comparison, the Mackenzie fund’s asset mix is relatively plain-vanilla. Its bond component, which represents 19% of AUM, is a case in point. Although that part of the fund portfolio is tactically managed, it is mainly composed of short-term government notes.

However, the fund’s managers are active within this narrowly defined space. As Morningstar Canada fund analyst Al Kellett points out: “Tiley sees a lot of value in ‘housing trust’ bonds. These are fully guaranteed by the Government of Canada and have historically traded a handful of basis points above government bonds. This year, as a reflection of widespread anxiety and a flight from all but the absolute highest-quality paper, that spread has blown out to upward of 40 bps, despite the bonds having no credit risk. As the spread has moved out, Tiley has been building his position.”

Even so, it is difficult to add value within this area.

Another advantage the CI Fund has over the Mackenzie fund is its low cost base. With a pint-sized 1.52% management expense ratio, it is one of the cheapest offerings in the global neutral balanced category. As a result, it has an instant leg up on the competition because it has a lower hurdle to overcome in order to remain in the black. The Mackenzie fund’s 2.36% MER is slightly more expensive than the category median.

A balanced fund should abide by a flexible strategy, add value with all facets of its portfolio and sport low fees. On that note, the CI fund hits the mark.

However, we think the Mackenzie fund’s management team is among the best value managers in the country. For balanced fund inves-tors interested in benefiting from the team’s expertise in equities, we suggest investing in the Mackenzie fund in combination with a top-notch bond fund that sports low fees. Naturally, investors would have to make their own asset-allocation decisions. IE



Jordan Benincasa is a fund analyst with Morningstar Canada in Toronto.