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Fund Spy

These 5 Balanced Funds Have Taken on More Credit Risk

Are they ripe for a setback?

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Moderate- and conservative-allocation funds, which respectively stash 50% to 70% and 20% to 50% of their assets in equities and typically invest most of the remainder in bonds, are often designed as core holdings. That mix of stocks and bonds can smooth over the rough patches that each asset class goes through over time. But as my colleague Christine Benz pointed out in a column last week, many of these funds take on significant credit risk, sporting average credit qualities of BB (the first notch below investment grade) or lower. While that profile isn't necessarily a reason to avoid an allocation fund, such positioning can increase a fund's sensitivity to the equity markets: High-yield bonds tend to decline in price when equities fall, so that core allocation holding may provide less cushion in a downturn than expected.

This article focuses on allocation funds that are taking on significantly more credit risk now--nearly six years into a bull market for high-yield bonds--than they did when high yield bottomed out in late 2008 (before equities hit their trough in March 2009) as the financial crisis deepened. Thus, each was late to the high-yield party to varying degrees. We limited the list to moderate- and conservative-allocation funds that hold at least 30% of their assets in bonds, as credit-quality changes will have less of an impact on funds with small bond stakes.

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