The global investor Sir John Templeton once said that “diversification should be the cornerstone of any investment programme”.
This is a great notion, without a doubt, but one that investors should approach carefully. After all, if taken too far, the benefit of diversification can be mitigated if allocation is spread too thinly across too many asset classes. A good compromise can be found in a style of mutual fund called balanced.
What is a balanced fund?
As their name suggests, such funds seek to strike a balance between investing in equities and in bonds. Appealing to those who want growth through equities with some protection against volatility, and those who want a bit more excitement than pure fixed income; balanced funds help to mitigate risk.
Leonardo da Vinci’s drawing the Vitruvian Man seeks to demonstrate the relationship between the different proportions of the human body, and this is how I tend to think of these types of funds. In the same way that the arms and legs have different functions but combine to provide an overall purpose, the elements of equities and fixed-income in a single balanced fund can do the same. Furthermore, balanced funds are able to support the idea that as an investor you have to go it alone, constantly seeking to fine-tune the mix of equities and bonds, because a balanced fund will manage this for you. A balanced fund maintains a diversified, balanced and risk-aware approach that can be tailored to suit investment goals.
Why should I consider this type of fund?
First, a balanced portfolio historically reflects less volatility than an equities-only portfolio. A hypothetical balanced portfolio consisting of 50 per cent equities and 50 per cent bonds, when compared to a range of MSCI, S&P and Russell indexes, has a lower standard deviation.
“What about bonds?” I hear you ask. Well, this is the second reason a balanced fund is worth considering: on average, it takes 19.4 years for a portfolio consisting of global bonds to double, but for a balanced portfolio, that number is less: 14.2 years.
The third reason to consider such a fund is because of a desired effect of balance – namely, stability. By this, I mean the reduction in the swings of investment returns. Looking again at equities for comparison, we see that they have performed well over the long term. However, returns can vary widely, even over short- term periods. Balanced funds, on the other hand, exhibited significantly lower negative returns than equities while delivering much of their growth. Data shows that over the 24 years between 1990 and 2014, equities had annual returns ranging from a loss of 8 per cent to a gain of 23.2 per cent. For a 50/50 balanced portfolio, this ranged from gains of 0.3 per cent to 13.7 per cent.
A balanced portfolio produces fewer down years. This is evidenced clearly when we look at data between 1991 and 2013 for market performance for equities and bonds. Equities had six down years, and bonds three years. Balanced funds, tellingly, produced a total of four down years in the same duration.
So why strike a balance when investing?
Simply put, it’s important to not put all of your eggs into one basket.
The bottom line is that balanced funds offer investors the option of simplicity and sophistication, wrapped into one: simplicity through a single diversified portfolio and sophistication through a range of choices, from portfolios designed around risk tolerance, to portfolios that shift more towards bonds or equities depending on the best opportunities.
What are the risks?
Nearly every investment entails special risks and all investors have unique needs. These aspects should be discussed with an experienced professional. Past performance is not a guarantee of future results. All investments involve risks, including possible loss of principal.
Dhiraj Rai is the director, Gulf & Eastern Mediterranean at Franklin Templeton Investments
