Finding Balance

Balanced funds often lag during bull markets because of their cash and fixed-income holdings, but the category’s best-run funds typically churn out steady returns and weather economic turmoil better than higher-flying fare.

James Balanced: Golden Rainbow (GLRBX) is a case in point. Last year, the fund lost only 5.5 percent, handily outperforming the S&P 500, which surrendered over 36 percent. These results are hardly an anomaly. Over the past three- and five-year periods, the fund generated returns of 1.26 percent and 4.86 percent, making it one of the better performers among its peers.

Part of this success stems from the fund’s portfolio allocation requirements. The fund typically invests 40 to 60 percent of its assets in common stocks and 40 to 60 percent in debt securities. And, management has the leeway to allocate up to 90 percent of resources toward either category if it deems necessary.

Of course, such flexibility is meaningless if the manager lacks the judgment to assess prevailing market trends correctly and adjust the fund’s portfolio holdings accordingly. Dr. Frank James has helmed the fund since its inception, successfully steering it through the stock market crash of 1987 and the tech implosion earlier this decade.

James attributes this steady performance to two components that work in tandem and reflect the firm’s commitment to both long-term capital appreciation and asset preservation: a quantitative model that identifies potential bargain stocks, and close attention to a proprietary mélange of over 100 economic, monetary and market risk indicators.

The manner in which the fund’s portfolio managers steeled the portfolio against the current economic crisis demonstrates the merit of this quantitative approach. Alarmed by movements in key risk indicators, management began to pare back the fund’s stock holdings in late 2007 while increasing its cash position and taking advantage of what Dr. James then regarded as “a real opportunity in Treasury bonds.” These prescient moves helped the fund avoid much of the carnage inflicted by the broader market.

James acknowledges that bonds will likely outperform equities in 2009 and has moved swiftly to scoop up bargains in the municipal bond market, select corporate bonds and US government agency bonds. But he also suggests that investor pessimism could be approaching a nadir and notes that many stocks are bargain-priced.

More recently, the management team has focused on adding to its collection of common stocks, which has increased from around 30 percent of overall assets to roughly 42 percent at the end of 2008.

However, that doesn’t mean that James and his team believe that the pain is over for the market; based on their hypothesis that stocks would experience a bear market rally, they’ve added selectively to their defensive positions.

For example, the fund has bulked up its holdings of grocer Kroger and fast-food chain McDonald’s (NYSE: MCD), two countercyclical firms that have held up fairly well despite the downturn in consumer spending. Other holdings include large-cap industry leaders such as AT&T (NYSE: T), IBM (NYSE: IBM) and Lockheed Martin (NYSE: LMT) that continue to perform. Management has also invested in companies with low price-to-earnings ratios that it believes the market has undervalued–for instance, security transportation firm Brink’s (NYSE: BCO).

As for the future, the fund’s managers are eyeing the commodities and basic material sectors where valuations are particularly attractive now that oil prices have plummeted from last summer’s highs. Chevron (NYSE: CVX), for example, boasts a strong balance sheet and is well-positioned to weather any continuing weakness in energy prices; nevertheless, the broad sell off pushed its share prices to lows unseen in years.

James and his research team are also bullish on Bob Evans Farms (NSDQ: BOBE), a company that operates a chain of almost 700 family restaurants and produces sausage and ham products found in grocery stores nationwide. “The stock’s taken a big hit without much cause; earnings haven’t been that bad, but the price fell from $30 to about $12. The stock usually carries a price-to-earnings ratio of about 19 but currently sells for about half of that,” James said.

While the fund relies on quantitative models to identify potentially undervalued stocks and guide broader portfolio allocation decisions, these moves are ultimately subject to the scrutiny and approval of a seven-member investment committee whose members have an average tenure of twenty years. This experience and accountability is reflected in the fund’s solid track record over the long haul, but potential investors should also be wary of efforts to time shorter-term market moves, though effective this go around, these moves aren’t always successful and have misfired in the past.

Still, for investors with a longer investment horizon looking for relatively stable performance in both bull and bear markets, James Balanced: Golden Rainbow could be an attractive option.

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