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Stuck in the Middle Not a Bad Place to Be With These Funds

A handful of analyst-recommended moderate-allocation funds have proved their mettle in good times and bad.

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With so much attention paid to selecting the right stock or bond fund, investors often seem to give short shrift to the humble allocation fund. These funds, formerly called balanced funds in the Morningstar lexicon, hold significant allocations to both stocks and bonds. Furthermore, they can act as a one-stop option for investors looking for a single investment vehicle to provide some of the return potential of stocks with some of the diversification and volatility-reducing qualities of bonds. (Of course, that bond exposure also brings with it interest-rate exposure, which could weigh on allocation-fund performance if rates continue to rise.)

Morningstar groups allocation funds into conservative (20%-50% equity exposure), moderate (50%-70% equity), and aggressive (70%-90% equity) categories. The biggest of these categories is moderate allocation, with more than 250 funds available. 

Given that allocation funds are designed to provide some of the performance upside of stocks with some of the downside protection of bonds, we thought we'd shine a spotlight on moderate-allocation funds that our analysts like and that have performed well through the ups and downs of the past five-year period. During that time the S&P 500 has returned about 7.6% annually (as of Aug. 23) while the Barclays Aggregate Bond Index, a proxy for the U.S. investment-grade bond index, has returned 4.9% per year.

As a benchmark for moderate-allocation fund performance we'll use the  Vanguard Balanced Index (VBINX) fund, which invests about 60% of assets in a cap-weighted index of nearly all U.S. stocks while holding about 40% in the cap-weighted Barclays Aggregate Bond Index. For the sake of comparison, the fund, which carries a Gold Morningstar Analyst Rating and which is a fine choice for those seeking a passively invested moderate-allocation vehicle, returned 7.4% per year during the past five years.

To make our screen, which Premium Members can access here, funds had to outperform the Vanguard fund proxy during the trailing five-year period and carry at least a Silver Analyst Rating. Our screen includes only no-load funds, but those who don't mind paying a load or who have access to no-load versions of such funds can remove that component if they so choose. We included only noninstitutional funds that currently are open to new investors.

Also, because the past five years have been dominated by a lengthy bull market, we thought it would be helpful to point out how a few of these quality moderate-allocation funds performed in years that were particularly good or particularly bad for the market. For our bad year, we'll use 2008, in which the S&P 500 fell 37% amid fallout from the financial crisis (note that the early part of that year is not included in five-year annualized return data). For our good year, we'll use 2012, when the index gained 16% as the economy appeared to stabilize. (Incidentally, our index proxy lost 22.2% in 2008 and gained 11.3% last year.)

 FPA Crescent (FPACX)     
5-Year Annualized Return: 7.8% | 2008: -20.6% | 2012: 10.3%    
Although most moderate-allocation funds tend to stick to large-cap stocks and high-quality bonds, this fund charts a more adventurous path. Morningstar analyst Dan Culloton describes manager Steve Romick as "an omnivorous contrarian who has demonstrated during two decades that he can sniff out value among stocks of all sizes and bonds of varying credit quality." The fund held nearly 30% of assets in cash at the end of June as Romick found a lack of attractive opportunities. Although this fund lagged our Vanguard index proxy by more than a point last year, it has more than made up for it in 2013, returning 13.6% as of Aug. 23 versus the proxy's 9.7% on the strength of strong performances by top equity holdings such as  Microsoft (MSFT),  Aon (AON), and  Thermo Fisher Scientific (TMO). Its long-term track record is even better, landing it in the top 5th percentile of moderate-allocation funds in the trailing 10- and 15-year periods. The fund charges 1.16% in expenses, above-average for a no-load fund in the category.

 Mairs & Power Balanced (MAPOX)   
5-Year Annualized Return: 9.2% | 2008: -21.1% | 2012: 17.3%    
Comanaged by Bill Frels, Morningstar's 2012 Domestic-Stock Fund Manager of the Year for his work with sibling  Mairs & Power Growth (MPGFX), this fund is in capable hands. Frels, who is expected to retire in December 2014, and comanager Ronald Kaliebe practice home bias to positive effect. They favor companies headquartered near their firm's home base of St. Paul, Minn., with more than one third of the equity portion of the portfolio from their state. Many of the companies owned by the fund have narrow or wide economic moats, meaning they have sustainable competitive advantages. Meanwhile, the fixed-income side of the portfolio is heavy on investment-grade corporate bonds. The fund has been a top long-term performer, with five- and 10-year annualized returns in the top 5th percentile of the category. The fund's 0.74% expense ratio is a bargain relative to the category average of 1%.

 Vanguard Wellington (VWELX)     
5-Year Annualized Return: 7.9% | 2008: -22.3% | 2012: 12.6%    
This reader favorite's average duration [a measure of interest-rate sensitivity] of 6 years in its bond portfolio (as of July 31 and according to the fund company's website) may give some investors pause in a rising-interest-rate environment. But Morningstar analyst Kevin McDevitt reminds investors that equities remain the primary driver of the fund's performance, which has been exceptional throughout its long history. In its present incarnation, the fund favors large, income-generating companies that increase earnings, and it also emphasizes investment-grade corporate bonds. The fund's 2.2% 30-day SEC yield and rock-bottom 0.25% expense ratio should help blunt the impact of rising rates on fund performance.

Five-year annualized returns as of Aug. 23. 

Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.