Settle for the Unconventional

Balanced funds offer a welcome respite for investors weary of market volatility. Because of their conservative equity allocations, these funds tend to lag the market during bull runs, while their bond allocations preserve capital during downturns. To that end, most balanced funds stuff their portfolios with staid large-cap stocks and A-rated bonds.

In contrast, Greenspring’s (GRSPX) equity sleeve is tilted toward small- and mid-cap stocks, while its bond sleeve dares to venture beyond investment grade. Nevertheless, Greenspring’s portfolio weathers bear markets with aplomb, while its equity sleeve produces returns that occasionally exceed the market during bull runs. Income-oriented investors should note Greenspring’s 3.5 percent yield, which it pays out in semiannual distributions to its shareholders.

The fund’s management prides itself on a “creative value” approach to security selection. Portfolio manager Chip Carlson, who’s been at the helm since 1987, mines what he terms the “inefficient sector”–undervalued stocks that boast a company-specific or industry-wide catalyst for appreciation, but are either out of favor or not widely followed by analysts.

The fund’s equity holdings tend to range from 40 to 60 percent of its portfolio; its most recent equity allocation was reported at 46 percent at the end of August. Nearly 47 percent of the fund’s equity sleeve is comprised of small- and micro-cap stocks, while mid-cap stocks account for just more than 32 percent.

Carlson looks for equities with significant amounts of free cash flow, which gives firms the flexibility to grow via reinvestment or acquisition. The fund recently initiated a position in NCI (NSDQ: NCIT), a government contractor that provides defense-related information technology services. Carlson also established a position in telecom equipment maker Tekelec (NSDQ: TKLC), which boasts what he calls a “pristine, cash-rich” balance sheet.

The fund’s value focus means that its portfolio can be fairly concentrated among industries. At the end of August, for example, its top-three industry weightings accounted for nearly 77 percent of its equity sleeve; the technology sector accounted for nearly a third of the fund’s stock holdings.

The average bond in Greenspring’s portfolio has a non-investment grade “B” rating, while nearly 64 percent of its bond holdings are unrated. Carlson mitigates the credit risk of this more speculative fare by focusing on shorter-term durations. Indeed, the average duration of Greenspring’s bond sleeve is just two years. More recently, management said it plans to continue investing in higher-coupon “cushion” bonds, which are callable bonds that pay a higher rate of interest to investors to compensate them for the risk that the bonds may not be redeemed by their first call date.

Convertible bonds comprise a substantial 36 percent of the fund’s bond sleeve. Once again, Carlson is anything but conventional, preferring “busted” convertibles–convertible bonds that trade well below the threshold at which bondholders could convert them into shares of the underlying stock. Although Carlson focuses his analysis on a firm’s ability to continue making interest payments, such bonds could become far more valuable should their underlying stock rebound to its conversion price. The fund also makes gains beyond mere yield when these bonds are redeemed early at a premium to par.

Greenspring has produced impressive long-term returns for a fund with such a substantial bond allocation. The fund beat the S&P 500 over the trailing five-, 10- and 15-year periods. Greenspring returned 7.4 percent annualized over the trailing 10-year period, for example, as compared to the S&P 500’s 3.9 percent annualized return. Over shorter-term periods, the fund should be expected to lag the broad market due to its bond allocation.

Of course, the fund truly stands out during bear markets. During the 2007-09 bear market, the fund’s largest rolling 12-month loss was 17.3 percent versus a 43.3 percent loss for the S&P 500. Despite navigating riskier investments than its peers in Morningstar’s Moderate Allocation category, the fund’s returns are slightly less volatile than the average fund in its category, and substantially less volatile than the broad market.

Greenspring can be a bulwark for investors’ portfolios in this volatile market, and its opportunistic stock picks should keep pace with the market once it renews its ascent.

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