Cautious investors drive strong balanced fund sales

By Donna Glasgow | November 12 2010 02:38PM

Fund investors are moving back into equities with a cautious approach that has resulted in strong sales of balanced funds, especially those with a conservative asset mix.

The Investment Fund Institute of Canada's statistical report shows balanced fund net sales for IFIC's member companies totalled $24.6 billion over the 12-month period as of the end of October, a sharp increase from $6.83 billion over the previous 12-month period. The balanced category includes standalone funds as well as popular fund-of-funds products, most of which fall within the balanced category.

The month of October was particularly strong for this category noted the IFIC report. "Balanced funds led the way in October with $1.98 billion in net sales, up from last month ($1.02 billion) and last October ($1.73 billion)."

Dennis Yanchus, Manager, Statistics and Research at IFIC, says, "People have taken part in the market recovery mostly through their balanced fund holdings." For investors who are concerned about the ongoing economic uncertainty, choosing a balanced fund is like hedging all their bets since they include a mix of assets. "If it turns out the fixed income side does better, you're there. If it turns out that equities recover, you've got some exposure to that... Depending on the portfolio, if gold does well, you might have some exposure there as well."

Mr. Yanchus explains that during the market downturn, investors stayed on the sidelines in money market funds (MMFs). The drop in interest rates affected MMF yields, so much of this money then moved into fixed income (bond) funds or high interest savings accounts.

Then, toward the end of 2009, the popularity of the fixed income category fell and balanced funds overtook them, although bond funds are still attracting significant sales. As of the end of October, bond fund sales for the 12-month period totalled $11.4 billion, up from sales of $8.80 billion during the previous 12-month period.

Mr. Yanchus says that the popularity of balanced funds indicates that investors are taking a cautious approach to the equity markets, but the sales strength is also part of a larger demographic shift. The aging of the population favours more conservative investments such as balanced funds, particularly fund of funds portfolio solutions. This trend was strong before the market crisis.

Brent Smith CIO, Franklin Templeton Multi-Asset Strategies and co-lead manager, Quotential Program, explains that he has noticed an interesting shift in balanced fund sales. "We're seeing the bulk of the inflows coming into much more conservative oriented balanced products." Sales are going to those with a 60% to 80% fixed income component, he says. "Historically, a lot more money flowed into aggressive balanced funds with 60% equity and upwards."

As of Sept. 30, Quotential's Diversified Income portfolio, a conservative, balanced portfolio, was composed of 77% fixed income, 16.2% Canadian equity, 3% gold and 3% cash. Assets under management were $1.15 billion. "We've seen tremendous flows into this fund portfolio."

For Mr. Smith, this conservative sales trend means that investors are wading back into the stock market gingerly. Various recent surveys have indicated growing investor optimism, but he is not seeing this yet. "With the huge rally after markets bottomed out in 2009, we expected investors would be more aggressive. I think investors are still wary. That's what we're seeing from the flows - a lot of wariness."

Lasting mark

He wonders if the bursting of the tech bubble a decade ago and the market crisis of 2008 has left a lasting mark on young investors, especially those in their 30s who may have just started investing ten years ago. These investors have earned little from the market and have experienced a rollercoaster ride of uncertainty and volatility. "There may be a whole generation of investors who are looking at the equity markets and thinking they are very, very risky. Is a lost decade of equity creating a generation of more conservative investors? I don't know the answer."

He adds that, "If you can take any positives out of 2008, it forced investors to re-evaluate their real tolerance to risk." During the market crisis, many found that their risk tolerance levels were much lower than they had thought. "Some say they want to earn 10% without risk...but you can't get great returns without risk."

Nessim Mansoor, Portfolio Manager, Equities, with Empire Life, co-manages a balanced segregated fund, the Asset Allocation Fund, with Gaelen Morphet and is the lead manager for the insurer's Premier Equity Fund, a Canadian-focused segregated fund.

He says the sales patterns in segregated funds have replicated those of mutual funds. "Money has gone out of money market funds into fixed income; it's gone into balanced funds and money has actually left pure equity funds as well, both Canadian and foreign equity."

Despite the capital guarantees offered by seg funds, investors are still "very wary" about their investment choices, he adds. Continuing economic uncertainty and negative headlines are contributing to this nervousness, Mr. Mansoor observes.

Volatility of stock market movements is also contributing to a lack of investor confidence. "The volatility we have seen this year in equities has been tremendous...that's very unnerving as well."

However, Mr. Mansoor believes that now is a good time to invest in the market since equity valuations are reasonable. "For someone who can ignore the noise and not be focused on the market, but be focused on portfolios of higher quality companies...that does pay off over time. Now is not the time to run away from equities."

Mr. Mansoor began co-managing the Asset Allocation fund back in February of this year. It is a tactically managed fund with an asset mix of 66% equities, 28% bonds and 6% cash. From February to the end of September, the fund's performance was 6.1%.

Investing decisions

Mr. Mansoor says that retail investors generally tend to base their investing decisions on past and recent performance. September was an excellent month for equities. Did this performance encourage investors to be more aggressive?

October's IFIC results showed continued redemptions in equity funds, and a continuation of strong net sales in fixed income funds, so there was no change in those trends, he explains. "However, net sales of balanced funds increased sharply from the month before and were the strongest in six months. This may be a tentative sign that investors are starting to increase their equity exposure cautiously by investing in balanced funds," he observed.

Les Grober, Managing Director of TD Asset Management, says since last year the main, overall trend he has observed is money leaving equities and flowing into bond funds. However, within the equity category, the bulk of the money is going into balanced funds.

He believes that investor confidence has improved over the past year, but is still fragile. "Just judging by the money flows, there is definitely a preference for current income as opposed to long term capital appreciation and I think that speaks to how fragile the economic recovery really is."

Mr. Grober is co-manager of the TD's Balanced Growth Fund with John Smolinski. The asset mix of the Balanced Growth Fund is roughly 60% equities (Canadian with some U.S. and International) and 40% bonds (with an emphasis on high quality corporate bonds).

Another TD fund that has a balanced mix is the TD Dividend Income Fund, which holds roughly 70% equities (Canadian dividend stocks as well as preferred and unit trusts) and 30% bonds with an emphasis on high quality corporate bonds. This fund's lead manager is Doug Warwick.

Mr. Grober suggests that for investors with longer investment time horizons, it would now be an appropriate strategy to pare back on bond exposure and favour equities. "When you look at the relative attractiveness of equities today versus bonds, equities are trading at pretty compelling valuations... Right now when you look at earnings yields or yields on a free cash flow basis, equities appear as cheap as they have been in many, many decades," he comments.

For investors with shorter time horizons, he says it might make sense for investors to maintain their position in bonds, given the potential downside risks for the global economy and concerns over deflation.

Who should buy balanced funds? Mr. Grober suggests that they are a good fit for two types of investors. The first is the retail customer with a low amount of assets who is looking to build wealth over time. "Balanced funds are a nice foundation to make up the core of one's portfolio."

The second category is baby boomers. "As the baby boomers continue to age and give greater consideration to the need to balance capital preservation with capital appreciation over time, I think balanced funds increasingly make sense, just given the more conservative nature of the product."

Dan Hallett, Director, Asset Management for Oakville, Ontario-based HighView Financial Group, says that for many years he was "very anti-balanced funds. It was really because balanced funds come with a premium price...whereas if you split up your money between a stock fund and a bond fund you can save quite a bit on fees, generally speaking."

What he came to realize, however, was that investors who buy balanced funds hold them longer and, as a result, experience better performance. The reason they hold them longer is that the asset mix of equities and bonds allows for smoother fund movements. A balanced fund portfolio that drops 20% during a market downturn doesn't provoke the same level of fear or panic as a standalone equity fund dropping 40%, for example.

Investors whose equity funds are separated from their bonds tend to get spooked even if overall their total portfolio has declined to the same level as a balanced fund. They have difficulty seeing part of their portfolio drop sharply and are more likely to sell it off at the wrong time.

Mr. Hallett says, "It would be nice if people were less emotional and more disciplined about (investing) and then they could save on fees. But the reality is this is not the case with most investors. So I would say by and large most investors can benefit from being in some kind of a balanced portfolio."

Also contributing to the balanced fund trend is that people become more sensitive to risk as their net worth grows and they have more to lose. The same thing happens as people age. "As we get older, especially as we near retirement, you say, ‘I don't have the 20 years to ride this thing out anymore' so you just grow more conservative over time," Mr. Hallett explains.


A key advantage of balanced funds is that the asset mix is rebalanced by the fund managers, Mr. Hallett adds. For example, when the stock market takes a drop, so does the equity level of the portfolio. A balanced fund manager will then rebalance by selling some of the bonds that have made money and by buying the stocks that have fallen in price.

It is very difficult to get the investors to balance their own portfolios in this way. "I would say the vast majority of people did not rebalance (during the recent downturn) and some advisors were challenged in the same way, whereas balanced funds and funds of funds, by and large, they did rebalance."

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