Ease Back Into Stocks With These Mutual Funds
Ben Baden

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Investors spooked by recent market volatility might want to consider so-called conservative allocation funds as a way to ease back into stocks, some experts say. These funds contain a mix of stocks and bonds, but generally invest less than half of their assets in equities. Instead, they focus on a range of fixed-income investments, cash, and sometimes commodities like gold.

"They do work well for people because they do moderate the highs and lows of the stock market, and often the bond and stock markets move in opposite directions," says Russ Kinnel, Morningstar's director of mutual fund research. "It doesn't always happen, but oftentimes there is certainly some diversification value there."

Before selecting a fund in this category, Kinnel says it's important to understand each fund's strategy. Some have a strict income focus and rely on dividend-paying stocks and high-yield bonds to provide consistent income for their shareholders. Other funds are designed for playing defense in bear markets and may not shine as brightly in good times.

Many funds maintain a fairly active asset allocation strategy--meaning management will make bets on certain sectors of the market if they see fit, while others follow a fixed target allocation that generally remains the same in any environment. "Right now, active allocation seems really appealing," Kinnel says. "But it's hard to do that right, and you have to recognize that you could end up doing worse than a set mix."

With that in mind, here is a list of five conservative allocation funds that have received high marks within the conservative allocation category, according to U.S. News's Mutual Fund Score.

Vanguard Wellesley Income.

Since its inception in 1970, the fund has returned an average of about 10 percent annually. Management works under tight allocation constraints. John Keogh of Wellington Management handles the fixed-income portion of the fund, which typically makes up 60 percent of the portfolio. He says the stock allocation for the fund fluctuates between 35 and 40 percent, and is fairly predictable. On the bond side, Keogh says the fund generally sticks to investment-grade corporate bonds and other high-quality securities like treasuries. The fund, like many in its category, has an income bias--meaning that managers look for yield in both stocks or bonds. The average dividend yield for stocks in the S&P 500 is currently about 2 percent, while the current dividend yield for the stocks in the Wellesley portfolio is 4 percent. Keogh says the fund's goal is to protect its clients on the downside. "When the bond markets really like risk as the bond markets have the past 12 months, we're probably going to underperform a little bit because we're [investing in] higher-quality [bonds] and higher-quality underperforms in that environment, but in 2008, being a little higher-quality is exactly what you wanted," he says. The fund returned 16 percent in 2009, 4 percentage points lower than the category average. But it outperformed its peers in 2008 when it only lost 10 percent, while the average fund in the category lost about 19 percent. The fund is the cheapest of the five listed here, with annual fees of 0.31 percent.

Permanent Portfolio.

This fund has a unique strategy that has produced an annualized return of almost 10 percent over the past decade. Management invests a fixed target percentage of its net assets in gold, silver, Swiss franc assets, stocks of U.S. and foreign real estate and natural resource companies, aggressive growth stocks, and fixed-income assets like treasuries. Generally, fixed-income securities make up the largest portion of the fund's total assets (35 percent) followed by gold (20 percent). The stock portfolio accounts for 30 percent of the fund's total assets, and investments in the Swiss franc make up 10 percent. Management also invests a small amount (5 percent) in silver. The fund charges 0.84 percent in annual fees.

Berwyn Income.

Although this fund falls in the conservative allocation category, management's main focus is generating income for clients. This means management will venture into higher-risk sectors like high-yield bonds to meet that income mandate. "Every investment in the fund is aimed at generating income," says co-manager Ray Munsch. Management can invest up to 30 percent in stocks, as long as they are strong dividend-payers. Co-manager George Cipolloni says the team will make major changes in the fund's allocation strategy if necessary. For instance, in late 2007, before the financial crisis took hold of the markets, Cipolloni says the fund went as low as 17 percent in stocks. Otherwise, the management team will invest in a mix of investment-grade and lower-quality bonds. Currently, a little more than half of the fund's assets are invested in corporate bonds. With assets of just under $1 billion, management is flexible and able to invest in stocks of all sizes. Over the past 10 years, the fund has returned about 9 percent, on average, which places it in the top 1 percent of its category. The fund charges annual fees of 0.70 percent.

Manning & Napier Pro-Blend Conservative Term.

Patrick Cunningham, managing director at Manning & Napier Advisors, says this fund's strategy is simple: Don't lose money. The fund is the most risk-averse of the firm'sfour balanced funds--which invest in a mix of stocks and bonds--that Manning & Napier manages. All of the company's balanced funds are managed with an active asset allocation strategy--meaning the allocation ratio in stocks and bonds will fluctuate, depending on the markets. The fund's weighting in stocks can range from as low as 5 percent to as high as 35 percent. "When markets were very expensive like they were at the end of 2000, we'll be at the low end of our allocation," Cunningham says. "When markets are very cheap--when they go through a significant correction--we'll beat the high end of our range." Currently, management has invested about a quarter of the portfolio's total assets in stocks. Generally, the fund will fall behind somewhat during huge market rallies, but it tends to hold up well during meltdowns like investors saw it 2008--when the fund only lost about 5 percent. Consequently, the fund only gained 10 percent in 2009, when its average peer saw gains closer to 20 percent. The fund has returned almost 6 percent on average over the past 10 years, and its annual expenses are 0.90 percent.

AARP Conservative.

This offering provides investors with a simple indexing strategy. All of AARP's asset allocation funds use an underlying blend of index funds. This fund aims to allocate 70 percent to bonds through an index fund that tracks the Barclays Capital U.S. Aggregate Bond Index, 22.5 percent to U.S. stocks through a fund that tracks the MSCI U.S. Investable Market 2500 Index (a mix of 2,500 stocks of all market caps that trade on the New York Stock Exchange and NASDAQ), and 7.5 percent to foreign stocks through a fund that tracks an international index. Generally, this fund will maintain that same allocation regardless of the market climate. The fund has returned almost 4 percent annualized since its inception in 2005. Index funds generally have lower expenses than actively-managed funds because they don't require a manager to select individual securities. This fund charges investors 0.50 percent in annual fees.

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