Beyond Bulls & Bears

Balancing Act

Shawn Lyons
Shawn Lyons

Most everyone is familiar with Alfred Hitchcock’s classic film Vertigo. These days, odds are good if you saw the title on a theater marquee, you might think it’s a haunting tale about investing. After all, an out-of-balance market that surges one day and retreats the next can leave one feeling more than a little unsteady.

As a co-portfolio manager for Franklin Balanced Fund with Ed Perks, Shawn Lyons spends a good deal of time thinking about how to achieve equilibrium between stocks and bonds and how to help cushion investments during a downturn while still making the most of competitive gains potential during market rallies:

“The Franklin Balanced strategy hinges on balancing the total return potential and appreciation potential of the stock component of the portfolio with the income-generating potential of the fixed-income component. We’re benchmarked against both the S&P 500 Index and the Barclays Capital U.S. Aggregate Index, so it’s a different blend of securities.”

As hybrid strategy vehicles, balanced funds take a unique approach in the common aim to achieve comparatively good performance in a variety of market conditions. Stock and bond positions in a balanced fund can vary within a range of percentages, based on the fund’s mandate. When the market experiences substantive changes, fund allocations are redirected to create what the managers feel is the most advantageous risk-return position. In terms of how Lyons manages a portfolio mix of stocks and bonds:

“We maintain at least a 25% exposure to both our equity and fixed income holdings at all times. So, the scale starts off in balance. From there, we do a top-down allocation assessment of whether or not we want to add more stocks, convertible bonds or fixed-income securities. So, we are constantly evaluating the changing economic data, the market data, as well as industry data. In the past, we’ve had a higher weighting of fixed-income holdings in our hybrid portfolios…today we are targeting a little higher equity weighting.” [1]

This shift reflects an environment in which some equity dividend yields have been higher than many bond yields. Thorough research and due diligence reveals which companies appear to have the best fundamentals for an equity position, as typically evidenced by expanding market share, strong balance sheets, healthy cash flows and long-term potential to maintain dividend payments. From a fixed income perspective, the greatest challenge is finding yield:   

“On the fixed-income side, it is a challenging environment right now. We’ve had 10-year U.S. Treasuries hovering around 2%…. What we are finding in the fixed-income market is that there are still opportunities in less rate-sensitive sectors. Investment-grade credit is one area where we have a significant weighting in the fund. In that particular area, you are getting 2.25% to 2.50% credit spread above the comparable Treasury…. But when we look at the fundamentals, we see many with strong balance sheets and cash flow, less leverage. So, that is—on a relative basis—a nice opportunity in the fixed-income market….”

Lyons cites much-maligned municipal bonds as another fixed-income sector presenting compelling opportunities in this volatile market:

“We’ve seen a lot of misinformation over the past year about munis, but you have 10-year municipals trading at 1.3 to 1.4 times the U.S. Treasury, which is a historically wide rate. So, there are always opportunities in the fixed-income market: sometimes, you just have to look harder.”

What might Sir John add on the topic of finding balance in a wobbly world?

“There are numerous reasons today why the stock market might go down.  Also, there are numerous reasons why it might go up.”

What Are the Risks?

The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. As the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate more dramatically over the short term as a result of factors affecting individual companies, industries or the securities market as a whole. These and other risk considerations are described more fully in the prospectus.

[1] As of 11/30/11, Franklin Balanced Fund’s exposure to equity and fixed income securities was 64% and 31% of its total assets, respectively. Holdings are subject to change.

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