(The author is a Reuters contributor. The opinions expressedare his own.)
By Lewis Braham
PITTSBURGH, March 21 (Reuters) - Freedom for money managersis a double-edged sword. Nothing highlights an active manager'sskill, or lack thereof, like flexibility. If you can buy anystock or bond, your opportunities to soar above your peers orcrash and burn increase dramatically.
The Lipper 2014 U.S. Fund Awards for the "mixed-asset" and"flexible portfolio" categories highlight the abilities of thebest go-anywhere managers. They must not only outperform onreturns but also assume the same or less risk than their peers.Lipper is a unit of Thomson Reuters Corp .
Since the funds are so flexible, figuring out where theybelong in your portfolio can be tricky. Are they bondsubstitutes, equity substitutes, or a little bit of both? It'shard to say, because strategies vary tremendously.
At Villere Balanced, a winner in the Mixed-AssetTarget Allocation Growth category, co-managers George Young andLamar Villere employ a bottom-up, kick-the-tires approach,seeking stocks and bonds of undiscovered, often small,companies.
Meanwhile, Kandarp Acharya, co-manager of Wells FargoAdvantage Index Asset Allocation and winner in the Mixed-AssetTarget Allocation Moderate category, uses a more top-down, macroapproach to determine how to allocate to indexes of large-capstocks and Treasury bonds.
The Wells Fargo fund is up an annualized 17.7 percent duringthe past five years through March 19, besting 97 percent of itspeers. Villere Balanced is up an annualized 22.7 percent for thesame period, outperforming 99 percent of its peers.
WORKING WITHIN LIMITS
Most flexible fund managers have some allocationrestrictions, but usually have a lot of leeway within thelimits. The Villere fund, for instance, can hold anywherebetween 25 percent and 40 percent in bonds. Right now, it has 27percent.
"We're fairly negative on bonds with interest rates so low,"Young says.
The fund is also fairly concentrated, holding only 25stocks. Young of Villere likes companies unknown to mostinvestors, like LKQ Corp, which has a 70 percent marketshare in the refurbished auto parts market. LKQ Corp has many ofthe features he seeks in a stock: a dominant position in itsindustry, strong cash flow and manageable debt levels.
EFFICIENT MARKETS
By contrast, Wells Fargo's Acharya says markets arereasonably efficient, so indexing makes sense, given thedifficulty most managers have beating their benchmarks. Activelymanaging the allocation to various assets can add value, henoted.
The academic research bears him out. According to studies,some 40 percent of portfolio performance at the average fund wasdue not to individual stock picking but to how much was instocks or bonds.
Acharya determines his allocations in part through aquantitative model that compares the relative prices of stocksto bonds. If price-earnings ratios of stocks are reasonablewhile bond yields are skimpy, as they are now, the fund tiltstoward stocks.
But models can be misleading if you rely solely on them. Soonce a month, Acharya convenes an eight-member investmentcommittee that includes the firm's top investment team, such asJim Paulsen, the chief investment strategist.
Most of the other Lipper winners with flexible stylesresemble Villere's bottom-up approach, but with importantdifferences. Take John Nichol, lead manager of the FederatedCapital Income Fund, winner in the Mixed-Asset TargetAllocation Conservative category. While he can buy virtually anyasset, Nichol's fund must always be at least 50 percent in bondsbut can go as high as 75 percent in that asset class. He hasdelivered a 7.4 percent annualized return over the past decade,besting 97 percent of his peers.
Right now, Nichol has almost one-half of his portfolio inhigh-yield and emerging-market bonds, which are paying the bestyields and are the least sensitive to interest-rate increases.Instead of picking individual securities in those sectors, heinvests in other funds run by Federated bond managers andfocuses on stocks with his own analyst team.
Most equity-income investors tend to go heavily in utilitystocks with high dividends. Nichol is flexible there, too. Hewill often switch between a high-dividend strategy and adividend-growth view, buying stocks with dividends that may below but increasing.
BEHAVING LIKE BONDS
In a rising interest-rate environment, high-dividend stocksusually fall as they behave like bonds. Last May and June, whenrates jumped by more than one percentage point, Nichol wasunderweight in utilities as he saw them as overvalued and wasoverweight in dividend-growth pharmaceutical and technologystocks. This minimized losses and enabled the fund to beat morethan 90 percent of its peers in 2013.
Now that high dividend payers have fallen some, Nichol iseasing back into the sector. The fund has 21 percent in energystocks like Royal Dutch Shell and ConocoPhillips, which have yields in excess of 4 percent.
While Federated Capital Income has an income tilt, ColumbiaMarsico Flexible Capital slants toward equities,requiring it be at least 60 percent in stocks. As the winner inthe global flexible portfolio category, it has 94 percent ofassets in stocks, but bonds have been as high as the teens, whenyields were in the double-digits in 2009.
Although stocks dominate now, part of the strategy ofFlexible Capital, according to co-manager Munish Malhotra, is toexamine the entire capital structure of a company to find thebest value. A holding like AutoZone Inc, which sellsreplacement vehicle parts, pays only 3 percent to 4 percentyields on its bonds, but is using the debt to buy back stock ata significant rate. The buybacks equate to an 8 percentdividend yield in Malhotra's calculations so he feels the stockis the better deal than the low paying bonds.
Figuring out where these eclectic funds belong in yourportfolio can be tricky. But given the skills of these managers,it's worth making room for them somewhere. (Follow us @ReutersMoney or at http://www.reuters.com/finance/personal-finance; Editing by Lauren Young and Jeffrey Benkoe)
