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Striking the Right Balance
Leith Wheeler Fund

Balanced funds combine both equity and fixed-income securities in one convenient package, but what is a fair price for this convenience? Cost-conscious investors should keep this question in mind when considering an investment in a balanced fund. This month I take a look at balanced funds from the frugal perspective and I focus on the Leith Wheeler Balanced fund in particular.

A common criticism of balanced funds is that investors are better off buying separate equity and fixed-income funds. Which of these two alternatives is cheaper, and which yields the better performance? These are tricky questions because one then needs to model balanced funds in terms of a portfolio of other funds.

Let's construct a model in which the equity component yields the same return as the average Canadian equity fund, and the fixed-income portion yields the return of an average bond fund. Let's also assume that the fees charged by the two components are just the median Management Expense Ratios (MERs) for their respective asset classes. Finally, choose the asset mix to be 60% equity and 40% fixed income. Our model portfolio then charges an effective MER of 2.1%, and would have returned an average of 7.9% annually over the past ten years. In contrast, the median MER for balanced funds is about 2.3%, and the average balanced fund return was 7.2%.

Two things are suggested by these results. First, balanced funds on average underperform a comparable mix of funds by an amount greater than the difference in MER levels. Second, having a professionally managed asset mix doesn't seem to have a positive impact on long-term performance. However, I am loathe to place too much emphasis on these conclusions because they are based on an arbitrary choice of benchmark (our model). Indeed, no single benchmark is good for all balanced funds. Nevertheless, these results give a rough idea of the real situation.

So, what should the frugal investor do? If you've decided that you want the convenience of a balanced fund, then you should observe the following two principles.

1) As always, fees should be kept to a minimum. This means looking for balanced funds that charge a MER of less than 1.4%. It also means only purchasing funds through a broker who will waive any load fees.

2) Within a given fund family (or fund company), the cost of a balanced fund should be no greater than the effective cost of a comparable portfolio of funds from the same family. If the balanced fund is much more expensive, then its convenience comes at too high a price and you're probably better off buying the funds separately.

Which funds are suitable choices for frugal investors? The balanced funds offered by Leith Wheeler, Perigee, McLean Budden, and Mawer all have MERs that are well below the median and that satisfy both of the principles mentioned above. These funds also have fine long-term track records. In what follows, I consider in more detail the balanced fund offered by Vancouver-based Leith Wheeler Investment Counsel (

Leith Wheeler Balanced

Since its inception in 1987, the Leith Wheeler Balanced fund has consistently outperformed the average Canadian balanced fund. The last three years have been particularly favourable, with the fund adding an average of 4.4% annually compared to only 0.4% for the average balanced fund. A sensible custom benchmark for this fund is 40% S&P/TSX Composite Total Return index, 20% S&P 500 index (C$), 35% Scotia Capital Markets (SCM) Bond Universe index, and 5% 91-Day T-Bill index. Over three years this blended index dropped an average of 1% annually.

Having defined a suitable benchmark we can now also check if the fund charges a competitive fee compared with its peers. Staying in the Leith Wheeler family, a portfolio of 40% Canadian Equity, 20% U.S. Equity, 35% Fixed Income, and 5% Money Market funds would have an effective MER of 1.10%. The Balanced fund charges the same amount and is fairly priced.

Managed by a team of four portfolio managers led by Neil Watson, the Leith Wheeler Balanced fund invests in Canadian and U.S. stocks as well as Canadian bonds. Sprucegrove Investment Management acts as sub-advisor for U.S. equities. The management team doesn't try to anticipate the best mix of stocks and bonds. Instead, the fund uses a strategic asset mix that is felt to provide reasonable levels of growth and income for the long term. This mix is reflected in the benchmark mentioned above.

As with all Leith Wheeler funds, stocks in the Balanced fund are selected using a bottom-up, value-based style. This means that the managers seek out money-making companies that are financially sound and have good growth prospects but that are undervalued by the market. Once purchased, a stock is normally held for two to four years unless there is an adverse change in the company's fundamentals, or if the risk-return characteristics of the stock become otherwise unfavourable.

For the fixed-income portion of the portfolio, the fund invests in high-quality government and corporate bonds rated BBB(low) or higher (using the Dominion Bond Rating Service scale). Normally the average credit quality of the fund's fixed-income holdings will be AA. The fixed-income portfolio's sensitivity to changes in interest rates does not usually deviate by very much from that of the SCM bond index.

To ensure adequate diversification and risk control, the fund operates under a number of constraints. For example, the minimum number of Canadian equities to be held in the portfolio is twenty-five, while for U.S. stocks the minimum number is forty. Similarly, corporate bonds may make up no more than 50% of fixed-income holdings and any single non-government bond rated below A(low) may not make up more than 5% of bond holdings.

At the end of 2002 the fund held 91 stocks and 41 bonds. Of its $63 million in assets, 40.4% was in Canadian equities, 35.3% in Canadian bonds, and 19.4% in U.S. equities. The fund also held a 4.7% cash position. These allocations are close to the fund's stated targets and didn't drift much during 2002. The top three equity sectors were Canadian financial services, Canadian industrials, and U.S. consumer discretionary. The top three stocks by market value were Royal Bank (RY), Manulife Financial (MFC), and Finning International (FTT). The fund was fairly active during the second half of 2002, eliminating 14 equity holdings and buying 9 new stocks. Notable moves included the sale of Bombardier (BBD.B) and Pharmacia (PHA), and the purchase of CIBC (CM).

On the fixed-income side, anticipating a rise in interest rates, the fund ended the year with a lower rate sensitivity than its benchmark and had a barbell maturity distribution. This means that bond holdings were concentrated in short-term and long-term holdings with relatively little weight in mid-term issues. Government of Canada bonds made up about 60% of the fixed-income portfolio. Only a small fraction was invested in provincial and municipal bonds. The largest single corporate bond was issued by BC Gas Utility Ltd and accounted for just over 1% of the fund's assets.

On a slightly negative note there are two points worth mentioning. The fund's turnover has been creeping up over the last few years and was a high 122% in 2001. This is at odds with the fund's stated long-term outlook. It should also be noted that the fund charges an annual fee of $25 on accounts whose balance falls below $50,000, which happens to be the minimum initial investment level. If you live in British Columbia you can purchase this fund directly through Leith Wheeler (1-888-292-1122 or 604-683-3391) or through a dealer. Those living in Alberta, Saskatchewan, Manitoba, or Ontario have no choice but to go through a dealer.

With a low 1.10% MER, a well-defined value-based stock selection approach, and a fifteen year average annual return of 8.8%, this fund is a bargain. More conservative frugal investors who seek the convenience of one-stop shopping should give it serious consideration.

When contemplating a balanced fund, ask yourself whether it might be cheaper to invest in separate equity and bond funds. In the end it is up to the individual investor to decide whether he or she has the time and the inclination to periodically monitor and adjust their portfolio. If you choose the balanced fund route, then be sure to minimize the costs.

Carl Wolfe, PhD

March 2003



Disclaimers: Consult with a qualified investment advisor before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...