Interest rates are slow–ly creeping upward and, as a result, equity investors are growing wary. So, it’s not surprising that domestic balanced funds are gaining popularity again, with the category enjoying the highest net inflow for the 12 months ended April 30 among those tracked by the Investment Funds Institute of Canada.
As a category, one-decision funds are designed to maintain an even keel. But for the past five years, at least, most managers have happily tilted toward equities. Over this period, balanced funds have had an average annual compound return of 7.9%, compared with 11.3% for Canadian stock funds and 4.6% for bond portfolios. Some funds, however, have outstripped these returns, and with lower risk as well.
Consider Toronto-based AGF Funds Inc. ’s $1.1-billion AGF Canadian Balanced Fund, an established fund that has registered a steady second-quartile return over several decades.
After producing a relatively weak 8.3% return in 2004, the AGF fund was an improved performer in 2005 with a 12.6% annual return. The fund was better still in 2006, producing a first-quartile return of 14.9%.
For the five months ended May 31, the AGF fund is up roughly 2.7%, producing a five-year average annual compound return of 9% — slightly more than most balanced funds.
Compare this with Toronto-based AIM Funds Management Inc. ’s $1.3-billion Trimark Growth & Income Fund, itself a strong performer. Up 13.9% in 2004, this offering lagged because of its lack of energy holdings in 2005, producing a meagre 4.1% annual return.
The Trimark fund bounced back nicely last year with a 12.9% return. Year-to-date, it is up an additional 2.7%, producing an 8.3% average annual compound rate of return for the five years.
Both funds receive three-star risk-adjusted rankings from Morningstar Canada, although the Trimark fund has been the stronger performer overall.
Both funds have managed to outperform the median fund in the balanced category over a number of periods.
Portfolio manager Christine Hughes joined AGF in 1999, after several years with Strategic Value Corp., which was acquired by AGF. Prior to that, she worked at Cassels Blaikie (now Scotia Cassels Investment Counsel Ltd.), managing portfolios for private clients.
Hughes is a growth-at-a-reasonable-price manager who likes to focus on earnings potential and improving returns on equity. She tends to make more significant shifts between stocks, bonds and cash than do most balanced fund managers, taking her cues from global interest rates and inflation trends.
She is also willing to make significant bets on which areas of the market are likely to burn hotter. That currently means materials, in which the AGF fund’s exposure, at 21%, is the third highest in the category. Energy is another sizable bet, at 20%. To mitigate this sector rotation, Hughes maintains a conservative stance by holding mostly government bonds rather than corporate issues.
As of mid-June, about 65% of the AGF fund’s holdings are in equities, with 29% in bonds. Cash is roughly 6%. The bulk of the stock portfolio is invested in Canada, with 13% split fairly evenly between the U.S. and Europe.
Geoff MacDonald has been with AIM Funds Management for the past 10 years. Previously, he worked at the Ontario Teachers’ Pension Plan Board, first as an analyst and then as a portfolio manager.
A value-seeking manager, MacDonald looks for companies with strong cash flow and management that are on the rebound following some adversity. Slow to trade, he will generally introduce only two or three companies a year.
He, too, will make significant sector bets from time to time, largely by steering away from hot sectors. This Trimark fund is one of just three in the balanced fund category with no exposure to energy stocks right now, Morningstar reports. And materials account for a scant 4% of the portfolio.
Asset mix decisions made by MacDonald and the Trimark bond team, led by Rex Chong, are based on a bottom-up approach to deciding which securities offer better value.
Most of the time, the balanced mandate means holding 50%- 65% in equities. Chong attempts to add value through corporate bonds rather than duration, which generally mimics the benchmark.
After inheriting the Trimark fund’s portfolio from Keith Graham four years ago, MacDonald increased the equity tilt, mainly by increasing the weighting of the existing names. He also boosted the foreign content sharply.
@page_break@Recently, 64% of the Trimark fund’s holdings were in equities, with 32% in bonds and 4% in cash. Unlike the AGF fund, MacDonald takes the Trimark fund further across the border, with a heavier emphasis on the U.S.
In total, 31% of the fund is invested outside Canada, a position that is often at least partially hedged.
Other than the major banks, there are few common names among the two funds’ holdings, and their bigger bets are quite different. Both hold roughly 45 to 50 stock positions, with their top 10 holdings accounting for 37% of assets.
For the AGF fund, the conventional valuation ratios are fairly similar to the average Canadian balanced fund and the Morningstar balanced benchmark. AGF’s Hughes leans toward large-cap stocks more than most because they offer liquidity in case she decides to adjust the fund’s equities exposure.
The Trimark fund, on the other hand, has a much higher P/E ratio than its peers and also contains more mid-cap stocks.
On the risk side, the Trimark fund has delivered less volatile returns than most of its peers and is clearly the less risky of the two funds. The AGF fund has a five-year standard deviation of 6.8, matching the benchmark but much higher than the Trimark fund’s 5.6 standard deviation.
During Hughes’ tenure, the AGF fund has generally beaten the category median in “up” markets while underperforming in poor markets.
Similarly, the AGF fund’s Sharpe calculation of 0.87 for five years lags the Trimark fund’s 0.96, reflecting the more conservative, diversified route the Trimark fund has taken.
Although both funds are solid offerings, the Trimark fund comes out ahead by most measures, particularly when you consider that the MER of 1.63% on this series makes it cheaper than 83% of its peers. A more expensive Series A version is available, with a different compensation structure for advisors.
Although the Trimark fund’s size does not appear to have affected returns so far, its hefty assets may make it more difficult for management to manoeuvre in the future, Morningstar cautions. IE
Balanced funds’ performance beats the median
Both AGF Canadian Balanced and Trimark Growth & Income get three-star risk-adjusted rankings from Morningstar Canada
- By: Gordon Powers
- July 3, 2007 October 30, 2019
- 11:59