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
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%
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
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
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