Interest rates are slowly creeping upward and, as a result, yield-hungry income trust investors are growing more wary. It’s not surprising, therefore, that balanced funds are coming back into vogue, with the category enjoying the highest net inflow this past February — $1.2 billion — since 1998.

As a category, one-decision funds are designed to hit the market’s middle. But for the past five years, at least, that has not been the case. Since the turn of the century, the average balanced fund has returned an annualized 3.8%, vs 4.3% for Canadian stock funds and 5.9% for bond portfolios.
Some funds, however, have outstripped these returns with lower risk as well.

One such offering is Dynamic Mutual Funds Ltd.’s $508-million Dynamic Focus + Balanced Fund, an established fund that has registered a steady first-quartile return since its inception in 1997. After producing a strong 18.8% return in 2003, the fund was a sound performer in 2004, as well, with a 7.5% annual return. For the three months ended March 31, the fund is up roughly 1%, producing a five-year average annual compound rate of return of 11.7%.

Compare this with CI Mutual Funds Inc.’s $2.2-billion Harbour Growth & Income Fund, itself a strong performer. Up 8.1% in 2003, this offering delivered an attractive 12.3% last year. Year-to-date, it is up an additional 4.5%, producing a 10.2% average annual compound rate of return for the five years — considerably more than most balanced funds.

Both funds receive five-star risk-adjusted rankings from Morningstar Canada, but the Dynamic fund has been the stronger performer, achieving superior results in both up and down markets. Both funds, however, have outperformed the average fund in this category over a variety of periods.

Ned Goodman, who heads the Dynamic Focus+ investment team, is CEO of Goodman & Co. Investment Counsel Ltd.
and founder of the Toronto-based Dundee group of companies. A co-founder and former partner of Beutel Goodman & Co. Ltd.
until his departure in the early 1990s, Goodman’s 40 years of investment experience is supported by Michael McHugh, who manages the fixed-income portion of the portfolio. McHugh began his career with defunct investment dealer Walwyn Stodgell Cochran Murray, and later managed private debt and equity portfolios for the Hospitals of Ontario Pension Plan.

CI Harbour Growth & Income Fund is managed by veteran Gerry Coleman, who joined CI in 1997 to establish the Harbour funds. Coleman began his career in finance with Montreal Trust, subsequently moving to United Financial Management Inc. and then to Mackenzie Financial Corp. to assist in the creation of the Ivy funds.

Prone to more aggressive calls than most balanced fund managers make, Coleman focuses on relative valuations among asset classes. Much of his ability to preserve capital in down markets can be attributed to his tendency to hold substantial amounts of cash. He has been sitting on a pile of cash (35%) for some time now, partly in
anticipation of rising interest rates, and holding a scant 5% in bonds — evenly split between Government of Canada short-maturity issues and real-return bonds — and 5% in income trusts.

The fund’s 56% equity weighting reflects his relatively bullish outlook. Bank and oil stocks continue to occupy almost 40% of the equity component.

As a stock-picker, Coleman is a self-described growth manager with a strong value bent, preferring companies with unencumbered financials, sound management and strong profit growth. To assess a stock’s true value, he and his team compare current valuations to their outlook for the business’s foreseeable future. Recent purchases include Australian resources company BHP Billiton Ltd.,
Citigroup and nickel producer Falconbridge Ltd.

Goodman, on the other hand, uses proprietary screens and a valuation model that stresses book value to identify stocks trading at deep discounts. The screens combine several balance sheet metrics, looking for growth companies that are trading at 66% or less of his fair value estimate. Many of the corporate bonds held are issued by the same companies that the fund holds in its stock portfolio.

Currently, about 31% of the Dynamic fund’s holdings is in equities, with 44% in bonds and 13% in income trusts. Cash is a significant 14%. Half of the stock portfolio is invested in Canada, with the other half invested almost entirely in the U.S. It underweights financials and slightly overweights resources. Major holdings include Calloway Golf Co., Placer Dome Inc.
and Canadian Pacific Ltd.