Heady performance by domestic equities means that most Canadian balanced funds have delivered returns of 10% or more in the past few years. Despite the threat of rising interest rates, conservative investors continue to favour these middle-of-the-road products. As a result, the fund group has seen exceptional growth, accounting for almost half of the $25 billion in net industry sales in 2005.

Two smaller balanced funds to compare are Howson Tattersall Investment Counsel Ltd. ’s $302-million Saxon Balanced Fund and the $1.1-billion AGF Canadian Balanced Fund from AGF Funds Inc.

After a 3% gain in 2002, when the average fund was off 5.5%, the Saxon fund delivered a 17.8% increase in 2003, eclipsing the benchmark return of 14.4% and just about every fund in its category. It was followed in 2004 by a 10.5% gain, vs the benchmark’s 9.8% return. In the 11 months ended Nov. 30, the fund was up another 8.7%.

The stellar results led to Saxon Balanced being named Canadian Balanced Fund of the Year at the 2005 Canadian Investment Awards, held in Toronto.

In comparison, the much older AGF fund slid 6% in 2002, along with most other funds on the category. The fund has performed better recently, delivering 12.9% in 2003 and 8.3% in 2004. For the 11 months, it registered an 8.3% return.

The Saxon and AGF funds each receive different risk-adjusted rankings from Morningstar Canada, earning five and three stars, respectively. With an average annual compound return of 12.5% for the five years ended Nov. 30, the Saxon fund has clearly been the stronger performer over the long haul. In fact, it has had only one negative calendar-year return in the past decade. In contrast, the AGF fund has delivered only 4.5% in the same period, which is more in line with the median fund in the category.

The Saxon fund’s manager, Richard Howson, is chief investment officer and partner at Howson Tattersall. After several years in research and portfolio management with CIBC Wood Gundy, he joined Howson Tattersall in 1989 and helped launch the Saxon funds.

AGF’s Christine Hughes started her career in 1990, managing segregated accounts for now-defunct Cassels Blaikie Investment Management. She subsequently moved to Strategic Value Corp. and joined AGF in 1999. A growth-at-a-reasonable-price

manager, Hughes looks at earnings potential and high returns on equity for guidance. On the bond side, she steers clear of corporate offerings, preferring instead to stick with lower-risk government bonds.

Howson says his value-based style, and the fact that he applies it consistently, is the key to the success of the Saxon fund. The equity portion of the fund closely resembles the portfolio of Saxon Stock Fund, in which Howson assesses corporate valuations relative to both the public markets and on an absolute basis using a proprietary valuation model. Prices are compared relative to a variety of balance-sheet measures — price/cash flow, price/book value and price/ revenue ratios — of which cash flow is the most important. Saxon fixed-income manager Peter Park favours corporate bonds, but usually those of shorter duration to moderate the company-specific risk.

Apart from a few companies that the two funds have in common, their holdings are significantly different. Both funds track about 50 stocks, with a fairly conventional split among stocks, bonds and cash, although the Saxon fund has about 7% in income trusts.

Recently, about 25% of the Saxon fund’s holdings were in Canadian bonds, with an additional 2% in foreign bonds. With no foreign equity content, 57% was in Canadian equities and the rest is in cash.

By contrast, AGF Canadian Balanced is working with about 12% cash, 53% Canadian stocks, 28% Canadian bonds and 3% foreign bonds. Virtually the entire stock portfolio is invested in Canada, with a small weighting in the U.S. and Europe.

Using the level and direction of interest rates as a key driver, Hughes has been considerably more active than Howson when it comes to adjusting her AGF fund’s asset mix, but portfolio turnover has dropped significantly in recent years, falling from 100% in 2000 to 36% in 2004, Morningstar reports.

Howson does not time his portfolio, but consistently maintains a higher-than-average tilt toward equities because they have outperformed bonds over the long term. For both funds, conventional valuation ratios are quite different from the median domestic balanced fund and the benchmark, Morningstar Balanced.

@page_break@Most noteworthy is the fact that Howson differentiates his fund by leaning toward more mid-cap stocks. The fund’s average market capitalization of $13.6 billion, vs the benchmark’s $22.6 billion, is smaller than that of most in the group, and its market cap has been consistently lower than its peers over the years.

The AGF fund has been overweighted in the energy sector, as well as in telecommunications, for some time. Hughes currently holds no technology stocks. Howson, on the other hand, favours industrial and consumer stocks, while remaining slightly underweighted in financials.he holds few technology stocks.

In the past five years, Saxon Balanced has delivered more volatile returns than its peers, and the AGF fund’s profile is the less risky of the two. Saxon Balanced has a five-year standard deviation of 7.7, but much of the added relative risk has been on the upside, Morningstar notes. In fact, the fund’s Sharpe calculation of 1.19 for five years ranks it at the top of its category.

In comparison, AGF Balanced’s five-year standard deviation is a lower 6.1 rating, yielding a five-year Sharpe ratio of only 0.27, which puts it squarely in the middle of the pack among its peers.

Although Saxon Balanced had some poor years in the late 1990s, when technology stocks were in favour, it has subsequently enjoyed a steady run and is worthy of attention. It may carry more risk than some balanced-fund investors are looking for, but it is a remarkably inexpensive choice with an established pedigree. And the fund’s management expense ratio of 1.87% makes it less expensive than 85% of its peers, Morningstar reports.

Two years ago, Howson and his partner Robert Tattersall sold a majority interest in their company to CMA Holdings Inc. , which oversees the MD funds for the medical profession, allowing them to market the Saxon brand outside of Ontario.

The improved distribution and industry recognition may have an impact on the relatively small fund family. Investing piles of money in short order can be a problem, especially for value managers such as Howson.

So far, however, additional inflows do not seem to have had a negative impact. IE