Advisor Invest With Confidence
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The Balanced Fund Evolution
While stocks and bonds are still an integral part of the balanced fund, creating the right portfolio for investors is a far different process today.
Date: March 7, 2018
If there’s one investment product that likely every Canadian has heard about, it’s the balanced fund. According to the Investment Funds Institute of Canada, $770-billion is invested in Canadian balanced products, which accounts for 52 per cent of all assets invested in Canadian mutual funds.
There’s one reason why it’s become such a popular product over the years: It’s simple. “It’s easy for an advisor to sell and for a client to understand,” says Michael Schnitman, senior-vice president of product at Mackenzie Investments. “There’s fixed income and there’s equity.”
However, people likely don’t realize that the balanced fund looks much different today than it did years ago. The balanced fund that most people are familiar with holds stocks and bonds – the standard is 60 per cent equities and 40 per cent fixed income, but the asset mix can change depending on an investor’s time horizon and risk tolerance.
While equities and fixed income are still integral to these products, the new generation of balanced funds are more focused on managing total portfolio risk than they were in the past. As investment experts have learned over time, just because a portfolio owns equities and fixed income doesn’t make it a low-risk fund, says Mr. Schnitman.
For instance, depending on what stocks are in a fund, it’s highly possible that 90 per cent of a fund’s risk could be concentrated in equities. If that’s the case, then when the market falls, so too will what was supposed to have been a downside-protecting fund.
Now, a main focus for managers of balanced funds is to generate the right return for one’s risk profile.
“If you’re taking one unit of risk, you must make sure you get the maximum return for it,” says Alain Bergeron, portfolio manager and senior vice-president of Mackenzie’s Asset Allocation Team.
Pension plan approach
One of the differences between the balanced funds of yesterday and today is that some managers now think of these portfolios as pension-like products with holistic risk management.
It’s how Mackenzie looks at its sophisticated balanced funds. While that’s partly due to Mr. Bergeron’s background – he spent a decade at the Canadian Pension Plan before joining Mackenzie – it’s also because research has shown that taking a more sophisticated approach to asset mix and risk leads to better investing.
“If you look at well-respected pension funds or endowments, they all have teams of experts in asset allocation and risk management, and that’s what’s called a total portfolio management approach,” says Mr. Bergeron. “It’s more complex, but it leads to a portfolio better aligned with the goals of the investor.”
Other balanced funds, such as the Mackenzie Diversified Alternatives Fund, are built explicitly to provide investors with a broad array of alternative assets, like real estate, private equity and hedge fund strategies, into their holdings that help diversify a traditional portfolio.
“You might have a good handle on your stocks and bonds, but there may be a need to complement the portfolio with more alternatives,” says Mr. Schnitman. “This helps investors create a complete portfolio.”
A deliberate process
Creating a pension-plan-inspired balanced fund is a multi-part process, says Mr. Bergeron. It starts with determining the optimal strategic asset allocation of a portfolio, which involves looking at every asset class a manager can tap into and coming up with the best long-term mix for the fund.
“You’re looking at the best set of weights between various asset classes and different geographies,” says Mr. Bergeron. “How much Canadian stock should you have versus U.S. and U.K. and emerging markets, and how much of foreign currencies should be hedged and so on? What is right? It’s a very deliberate process.”
After Mr. Bergeron is satisfied with the long-term weights he’s given to each asset class, he’ll make smaller adjustments to the fund’s asset mix depending on what’s happening in the world today.
It’s called tactical asset allocation and it allows him to underweight one part of the portfolio in favour of another if he feels there’s more opportunity in a particular area today.
The next step is deciding how he should obtain the exposure to his various asset classes. Say he decides to have a 10 per cent allocation to Europe, should he get it through an ETF? Buy stocks directly? Is there a talented active manager who specializes in the region?
He evaluates how much he should expect to get on top of an index’s return and then looks at how to get it, and how much risk the manager has to take to generate extra return, or what Mr. Bergeron refers to as “alpha.”
The last step is involves viewing the fund from a risk-management perspective. “How do all the assets interact so that it stays within the parameters we’re aiming for?” he asks. “That requires a fair amount of technology and people.”
With the traditional balanced funds, assets are allocated to fixed income and equity managers who would just try to beat their benchmark, but little thought would be given on how each one interacted with one another in real time. With this more sophisticated approach, balanced fund managers now look at how the portfolio holdings and strategies interact continuously, and ultimately how the positions add to risk or the diversity the portfolio.
There’s another difference with today’s sophisticated balanced funds: This process can be customized to deliver on specific outcomes, which gives investors and their advisors the opportunity to choose the balanced fund that suits them best and meets their goals. Mackenzie has funds focused on income, growth, downside risk reduction and more.
Ultimately, the idea is to help investors generate above-market returns, without feeling panicked every time the market falls. “There are now many ways of helping investors achieve the outcomes they need,” says Mr. Schnitman. “And multi-asset solutions are a key part of that.”
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