Balanced Funds
Balanced funds (also known as multi-asset funds) are by far the most popular unit trusts and is the vehicle of choice for many investors saving for retirement. Balanced funds are designed to achieve long-term real returns in a more stable and consistent manner than a single asset class fund (like equity funds). They use a combination of different asset classes to maximise real return (after inflation) while being cognisant of risk. This article explores the typical construction and variants of these funds on offer to South African investors.
Asset allocation of balanced funds
Balanced funds generally seek to maximise risk-adjusted return. This means that the fund manager needs to construct a portfolio that could generate attractive returns while reducing the likelihood of making losses. This is achieved by including different asset classes in the portfolio like local or international equity, bonds and property.
The asset split depends on the aggressiveness of the fund’s mandate i.e. whether the goal is capital preservation or growth. A fund that aims to generate capital growth will allocate a higher proportion of assets to equity. This makes the fund more aggressive and adds risk, but also has the potential to deliver higher return. If the aim is to preserve capital by beating inflation, then the fund manager will allocate less of the portfolio to equity and buy less risky assets like bonds and money market instruments.
Fund managers can actively manage the asset allocation of the portfolio or elect to keep the asset split near pre-determined weights. The benefit of actively managing the asset allocation is that fund managers can purchase the asset class that is expected to deliver the highest return. If there is pessimism in equity markets then the fund manager can switch from equity into bonds and cash to avoid losses. This method has higher transaction costs and adds the risk that the fund manager makes a bad call on selecting asset classes. Therefore, fund managers often hold the portfolio’s construction close to its strategic weight. The strategic weight of the portfolio is the asset split that has historically delivered the most attractive return for a certain level of risk over the long term.
How to Choose Between the Types of Balanced Funds
Balanced funds can be divided into different risk categories ranging from cautious to aggressive. One method for investors to distinguish between these categories is to look at the sector that the fund is classified in. Most Balanced funds are divided into four sectors namely, Multi-Asset Flexible, Multi-Asset High Equity, Multi-Asset Medium Equity, Multi-Asset Low Equity.
The Multi-Asset Flexible sector includes funds that have flexibility in their asset allocations. The Sharenet BCI Flexible Fund can be placed in this category. Most flexible funds are managed with active asset allocation and aims to maximise long term growth. Some fund managers in this sector use the flexibility of switching between asset classes to manage the risk in their portfolios.
The Multi-Asset High Equity sector is the category of funds most popular among retirement savers. Funds within this category are limited to a maximum of 75% in equity and the funds eligible for retirement savers have an additional limit of 25% international exposure. The Sharenet BCI Balanced Fund is a great option if you are looking for this type of fund. High Equity Balanced Funds are designed to grow capital over the long term while diversifying across asset classes to add more stability to returns. Investors with a moderate to aggressive risk profile, like those saving for retirement, are most suited to these funds. If you are looking for a step-by-step guide on how to invest for retirement then read our article on Saving for Retirement.
Funds in the High Equity sector usually don’t generate enough income for investors looking to periodically withdraw money. These investors can find cautious funds in the Medium-and Low Equity sectors that allocate more to income generating assets. The funds are typically used by investors who have already retired and provide more stability in returns with a constant stream of income.
Conclusion
There are multiple strategies used by balanced fund managers with a degree of asset allocation decisions faced by each fund. Some fund managers are very active when it comes to switching between asset classes like equity and cash while others prefer to stick to an allocation that does its job in delivering attractive returns over time.
There are mainly three types of balanced funds split into different risk categories (cautious, moderate and aggressive). Sharenet offers its clients a simple entry into one of these fund categories with its fund of funds range:
Cautious – Sharenet BCI Conservative FoF
Moderate – Sharenet BCI Moderate FoF