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When the Market Teeters and Totters, These Funds Provide Balance


As the great bull market has stumbled in recent weeks, attention has focused on how some investors have shifted a small portion of their mutual fund assets from the gyrating stock market to the terra firma of money market funds.

What has gone relatively unnoticed is another trend signaling caution, one that has been going on since the beginning of the year.

Rather than give up stocks cold turkey, many investors are choosing to wean themselves of market risk by exchanging pure-stock portfolios for less volatile "balanced" funds, which invest in a mix of stocks and bonds.

At Scudder Kemper Funds, more money has flowed into the firm's balanced portfolios thus far this year than in all of 1997. And spokeswoman Meg Pier said inflows into these portfolios now are "well ahead of 1994's record pace"--the last disappointing year for domestic equities.

In July, as the stock market fell sharply, the pace of money flowing into balanced funds sold by the Vanguard Group, the nation's second-largest mutual fund company, surged. A net $365 million flowed into the company's balanced funds last month, up 65% from June's inflow, said spokesman Brian Mattes.

Some financial advisors say investors are doing precisely the right thing. "This is one hell of a smart move," said Gerald Perritt, president of Perritt Capital Management in Chicago and editor of the Mutual Fund Letter.

Running to money market funds for safety sounds logical, but those funds shouldn't hold long-term savings, many pros say.

Why not? "They don't pay anything," Perritt notes.

The typical money market fund now yields 5.16%, annualized, according to IBC's Money Fund Report, a trade weekly based in Ashland, Mass.

After taxes and inflation, investors may wind up earning as little as 2% in real terms, said Perritt. "You'd have to work until you're 97 to make enough to retire at that rate."

The typical balanced fund, on the other hand, has delivered annualized returns of 12.7% over the last 15 years, according to Chicago fund tracker Morningstar Inc. That's nearly as much as domestic equity funds' 13.2% average annualized return over the same period.

Yet the typical balanced fund has been nearly half as volatile as the typical domestic stock fund over the last three years, as measured by standard deviation.

Standard deviation judges a fund's volatility based on how far its returns stray, or deviate, from its average return over an extended period.

By mixing stocks with interest-paying bonds and usually some money market securities as well, balanced funds allow investors to stay in the stock market while maintaining a buffer against a horrendous market decline.

"Balanced funds make a lot of sense for investors who don't have the money or the time to allocate their portfolios themselves," said Larry Chin, senior editor of the No-Load Fund Analyst, a newsletter based in Orinda, Calif.

Balanced funds also provide an easy way to rebalance your portfolio if you're over-weighted in equities not by design, but because of the market's heady gains in recent years, financial planners say.

To identify some high-performing balanced funds, we started with Morningstar's database of 668 "domestic hybrid" funds.

That's the firm's umbrella term for balanced funds and those that act like balanced funds, even if they aren't classified as such.

Performance obviously matters. So we eliminated all those portfolios that didn't beat at least 75% of their peers over the past three- and five-year periods.

Next, we sought relative safety. We did this in three ways.


First, we screened out all balaned funds that Morningstar considers riskier than the category average.

Then we eliminated funds whose bond holdings were predominantly low grade--in other words, junk issues--or long-term.

Why cut out funds that primarily own long-term bonds? The longer a bond's term, the more at risk it is to market interest rate fluctuations. Yet these days, long-term bond holders aren't compensated for taking that additional risk.

Consider: The yield on 30-year U.S. Treasury bonds now is 5.62%. That isn't much more than what money market funds pay.

"It's not worth investing in long bonds," says Ridgewood, N.J., financial planner Paul Westbrook.

Finally, we screened for low standard deviation. The standard deviation of the average domestic equity fund, expressed numerically, is 16.4 over the last three years. We eliminated all balanced funds with a standard deviation of 10 or higher.

This left us with 12 funds, but we pared the list down to 10 because two of the portfolios required initial investments of $25,000 or more.

Details on the 10 finalists:

* Gabelli Westwood Balanced (no-load; $1,000 minimum initial investment; phone: [800] 937-8966). Co-manager Susan Byrne relies on the same stock-picking methods for this $129-million portfolio that she uses for the respected Westwood Equity fund.

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