Managers of Canada’s
asset-allocation funds don’t necessarily agree on what it will take to protect profits following the ongoing run-up in prices. But they still tend to favour equities over bonds.

In the face of rising interest rates, Fidelity Investments Canada Ltd. ’s $2.7-billion Fidelity Canadian Asset Allocation Fund Series A is adopting a fairly bullish approach. It is holding 11% of its assets in cash and roughly 64% in stocks, 4% in income trusts and 21% in bonds.

Other asset allocators have also slightly boosted their weightings in stocks and are leaning away from bonds. One example is Franklin Templeton Investments Corp. ’s $122-million Templeton Canadian Asset Allocation Fund. It has about 61% in stocks, 4% in income trusts, 32% in bonds and just 3% in cash.

After producing relatively strong annual returns early in the decade, the Templeton fund has struggled lately, earning a disappointing 2.4% in 2004, 7.2% in 2005 and 6.8% last year. The annual returns are all well below those of the median fund in its category. Year-to-date, however, the fund is up a healthy 6.5%.

The Fidelity fund, on the other hand, has thrived, earning 10.7% in 2004, 14% in 2005 and 11.7% last year, sharply eclipsing the median fund’s returns each time. It’s up a further 5.4% for the six months ended June 30.

The two funds receive different risk-adjusted rankings from Morningstar Canada: four stars for Fidelity and two for Templeton. Their five-year average annual compound returns as of June 30 differ as well: a first-quartile 10.2% for the Fidelity fund; a fourth-quartile 6.3% for the Templeton fund. The median asset-allocation fund gained 8.5% in the same period.

Whether the Fidelity fund’s outstanding performance can continue remains to be seen. Long-time manager Alan Radlo, who oversaw about 25% of the fund company’s assets, left Fidelity at the end of 2006. Bob Haber, a 22-year veteran and Fidelity Canada’s chief investment officer, took his place and has boosted the fund’s equity portion slightly, while continuing its tilt toward energy issues relative to the S&P/TSX composite index.

Unlike Radlo, however, who was always trying to find the least risky way to own more stocks, Haber is not expected to let the fund’s sector weights deviate much from the index in the future.

As well, given Fidelity management’s reluctance to make calls on interest rates, it is difficult to see where this fund is going to add the value that has distinguished it from its competitors in the past. As a result, Morningstar and other analysts expect the fund’s correlation to the index to rise over time.

At Templeton, the world is divided by sector or industry. The division is then cross-layered with country-specific coverage. Enter Peter Moeschter, now in his tenth year on the team overseeing the fund. Prior to joining Templeton, he worked for the Workers’ Compensation Board of Ontario and the pension fund division of what was then Ontario Hydro.

Moeschter likes to spread assets across as many sectors as possible and has no firm limits on sector weightings. Right now, that means significantly lower energy holdings and a heavier weighting in telecommunications and technology.

Surprising in a Templeton fund, Moeschter has foreign content at less than 7%, including foreign bonds, with a slight bias toward international rather than U.S. stocks. The Fidelity fund’s foreign holdings, on the other hand, are running at almost 18%. Neither manager hedges foreign currency exposure.

With a relatively concentrated portfolio of 50 stocks, the Temple-ton fund’s top holdings account for about 23% of assets. With 234 stocks, the Fidelity fund nevertheless plants a much larger portion of its assets — about 33% — in its top 10 holdings.

Both managers primarily invest in large-cap stocks, but the Fidelity fund historically has featured more mid-cap names than its rival. Both funds carry lower price/earnings and price/book ratios than the majority of their counterparts. The Templeton fund’s dividend yield is slightly lower than that of the Fidelity fund.

The funds present different risk profiles, favouring the Fidelity fund with its standard deviation of 6.3 in the past five years, vs the Templeton fund’s 8.2 — another measure that is much higher than the median fund in the category.

The funds’ relative Sharpe ratios indicate that the Fidelity fund has been the better risk-adjusted performer in the period, eclipsing the median fund. But the gap between the two funds has shrunk slightly in the most recent three-year period.

@page_break@On balance, the nod has to go to the Fidelity fund, an above-average performer since its inception. However, its 2.48% MER, an unwieldy asset size of more than $6 billion held in various series and a retooled approach that leaves less room for smaller-cap stocks make it improbable that the fund will be able to beat its benchmark consistently over the long term, Morningstar predicts. IE