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MFS
Paper Series
Focus
Month
June 2015
2012

STRIKING A BALANCE

Author

How balanced funds help investors gain exposure to

upside potential and mitigate downside risk
David W. Connelly
Director, Global Product

IN BRIEF
Investors have frequently sold assets in markets about to rise and
bought into markets about to fall, in effect allowing emotions to guide
short-term decisions at the expense of longer-term investment
performance.
C
 ombining stocks and bonds in a balanced fund offers investors
diversification and the opportunity to achieve improved risk-adjusted
performance.
T he historical performance of a 60% stock and 40% bond portfolio,
rebalanced quarterly, demonstrates that investors can take advantage
ofthe outperforming asset class while limiting the impact of the
underperforming one.
T he 60/40 balanced portfolio provides an opportunity for improved riskadjusted performance, capturing 90% of the return delivered by equities
with only 65% of the volatility (based on historical performance).

BUILDING
BUILDING
BETTER
BETTERSM
INSIGHTS

INSIGHTS

Investors have a tendency to be swayed by emotion, often buying

at the top of the market and selling when it is at its nadir, with the
resulting adverse effect on investment performance. Even savvy
investors can be drawn in by the lure of a raging bull market or
cowed into submission by plunging stock market returns. When
one looks at asset classes individually, volatile swings in performance
come into high relief, and the urge to chase good performance and
run from weak performance is strong.
In this paper, we discuss how taking advantage of the combined performance of
multiple asset classes in the form of balanced funds provides the potential for
investors to achieve improved risk-adjusted performance. Combining stocks and
bonds in one fund can help to mitigate investors propensity to buy high and sell

JUNE 2015 / STRIKING A BALANCE

A balanced approach can help mitigate investors

propensity to buy high, sell low

low; therefore, these funds tend to have lower redemption

rates relative to single-asset-class funds (see Exhibit 2).
These funds also have risk benefits: Balanced portfolios
provide exposure to equities along with some down-side
risk management strategies and lower volatility than allequity portfolios.

As shown in Exhibit 1, it is usually detrimental for investors

to move in and out of asset classes in response to recent
market returns. Investors are generally better served by
engaging in persistence, i.e., remaining invested through a
full market cycle.

A closer look at investor buying habits

While the traditional investment adage to buy low, sell
high makes intuitive sense, it is often difficult to adhere to
when uncertainty is rampant and investors are acting in
keeping with their tendency to look in the rearview mirror.
The stock market volatility since 2000 and the investment
habits of investors illustrate the tendency to buy high and sell
low. Exhibit 1 breaks the performance of the S&P 500 Index
into periods of generally positive or negative performance
and shows the flow of money into equity mutual funds in
the prior 12 months of each period.
As the period of declining markets was coming to an end
and equities were becoming more attractively valued (the
period 1/00 to 2/03) more investors were moving out of
equity funds than into them (outflows of US$65 billion were
recorded), missing the subsequent market rally. Conversely,
as the mid-decade market rise was nearing its end and stock
prices were peaking (the period 3/03 to 9/07), investors were
pouring assets into equity funds, with US$105 billion posted
in net inflows. In the final period shown, markets rose, while
equity flows have been moderately positive.

While we are unable to compare holding periods directly,

Exhibit 2 compares mutual fund redemption rates by broad
asset class groupings. Redemption rates can be used to make
inferences, at least directionally, about the relative intensity of
trading activity seen in different investment products. This
provides an indication of which types of products might be
less prone to market timing.
Based on five-year rolling redemption rate data from the
Investment Company Institute (ICI), hybrid funds, including
balanced and other multi-asset strategies, exhibited the
lowest redemption rates of the five fund types monitored
by ICI.
Exhibit 2: Average rolling 12-month redemption rates
for the five years ended December 2014
36.0%
27.7%

29.6%
26.3%
23.0%

 xhibit 1: Investors unsuccessful at timing stock

E
market shifts
Investors moved assets out of the stock market when it was
bottoming andinto stocks when they were close to their peaks.

Time period

Market
environment

S&P 500
cumulative
return

Equity fund flows

last 12 months
of each period

1/00 to 2/03

Falling

-40.15%

-$65 billion

3/03 to 9/07

Rising

97.21%

$105 billion

10/07 to 2/09

Falling

-50.17%

-$208 billion

3/09 to 12/14

Rising

217.07%

$25 billion

US
equity

World
equity

Hybrid
(balanced)

Municipal
bonds

Taxable
bonds

The average redemption rate is the average of five years of rolling 12-month
redemption totals expressed as a percentage of the average AUM for that
same period and includes both redemption and exchange figures from the
ICI Trends report.
Source: Investment Company Institute (ICI).

Sources: SPAR, FactSet Research Systems Inc., ICI/Strategic Insight.

JUNE 2015 / STRIKING A BALANCE

Exhibit 3: Bridging the performance gap between stocks and bonds

Calendar-year performance differential relative to a quarterly rebalanced 60% stock/40% bond portfolio.
100%
BONDS

60% STOCKS
40% BONDS

100%
STOCKS

1976

15.60

20.69

23.93

1977

3.04

-3.13

-7.16

1978

1.39

4.65

6.57

1979

1.93

11.77

18.61

1980

2.71

20.25

32.50

-30%

-20%

-10%

0%

10%

20%

30%

1981

6.25

-0.53

-4.92

1982

32.62

26.20

21.55

1983

8.36

16.84

22.56

1984

15.15

9.79

6.27

1985

22.10

28.03

31.73

1986

15.26

17.50

18.67

1987

2.76

6.04

5.25

1988

7.89

13.09

16.61

1989

14.53

24.71

31.69

1990

8.96

1.88

-3.10

1991

16.00

24.67

30.47

1992

7.40

7.57

7.62
10.08

1993

9.75

9.96

1994

-2.92

-0.37

1.32

1995

18.47

29.69

37.58

1996

3.63

14.95

22.96

1997

9.65

23.59

33.36

1998

8.69

21.24

28.58

1999

-0.82

12.22

21.04

2000

11.63

-1.10

-9.10

2001

8.44

-3.34

-11.89

2002

10.25

-9.49

-22.10

2003

4.10

18.64

28.68

2004

4.34

8.35

10.88

2005

2.43

3.94

4.91

2006

4.33

11.14

15.79

2007

6.97

6.19

5.49

2008

5.24

-21.63

-37.00

2009

5.93

18.46

26.46

2010

6.54

12.19

15.06

2011

7.84

4.98

2.11

2012

4.21

11.37

16.00

2013

-2.02

17.73

32.39

2014

5.97

10.56

13.69

-30%

-20%

-10%

0%

10%

20%

30%

Stocks as represented by the S&P 500 Index, which measures the broad US stock market.
Bonds as represented by the Barclays U.S. Aggregate Bond Index, which measures the US bond market.
Source: SPAR, FactSet Research Systems Inc. Please note that the outperformance of 60/40 portfolio in 1987 to both stocks and bonds was the result of quarterly rebalancing.
The start of the period coincides with the inception of the Barclays U.S. Aggregate Bond Index. It is not possible to invest directly in an index. Past performance is no
guarantee of future results.

JUNE 2015 / STRIKING A BALANCE

The lower redemption rates of hybrid/balanced funds imply

that investors hold these funds relatively longer than they do
other types of products. MFS believes investors in balanced
funds are likely to gain comfort from the diversification
benefits they provide, counteracting the natural instinct to
bet on the direction of the market and move in and out of
different asset classes.

volatility is to combine stocks and bonds in a balanced

portfolio. The historical performance of a traditional 60%
stock and 40% bond portfolio, rebalanced quarterly,
illustrates how a multi-asset-class fund has cushioned market
peaks and valleys for investors.

Balanced funds can help moderate the volatility

of stocks and bonds
Over the long term, equities have delivered greater returns
than bonds, compensating investors for taking on the
relatively higher risk of equity investments. Over the past
39 years, stocks, as measured by the S&P 500, have delivered
an average annualized return of 11.62%, while bonds, as
measured by the Barclays U.S. Aggregate Bond Index, have
delivered average annual returns of 7.86%. However, as
investors are acutely aware, shorter-term equity returns are
more volatile than those of fixed-income securities.
Additionally, if we look at calendar-year returns, we see
that the performance relationship between the two asset
classes is highly variable. Over the past 39 calendar years,
stocks have outperformed more frequently (28 times) by an
average of 13.10% over bonds in those years. Bonds have
outperformed less frequently (11 times), but by a more
significant average differential in those years, of 16.02%.
A proven, straightforward approach to accessing the longterm excess returns equities provide, while moderating their

Exhibit 3 shows calendar-year returns for stocks, bonds and a

60% stock/40% bond mix. The graph displays the calendaryear return differential of both stocks and bonds relative to
the 60/40 mix. While the year-to-year performance
relationship between stocks and bonds has often shifted
dramatically, a 60/40 mix has typically landed somewhere in
between by providing participation in the outperforming
asset class while limiting the impact of the underperforming
one. Although investors can get the same exposure by
holding stock and bond funds separately, a balanced fund
that combines asset classes can help investors combat the
natural urge to chase the outperforming asset class and
abandon the underperforming one.

Negative equity returns are mitigated with a

multiassetclass approach
As we have observed in the last decade or so, short-term
negative returns cause investors to lose resolve and abandon
longer-term investment strategy. In fact, investors often focus
on avoiding short-term losses at the expense of longer-term
investment objectives, a behavior called myopic loss aversion
within behavioral finance circles.

Exhibit 4: How bad was it? Not as bad with a balanced approach.
A 60/40 mix cushioned the degree and frequency of losses. Rolling 12-month periods from January 1976 to December 2014.

S&P 500 Index

60% S&P 500 Index / 40% Barclays U.S. Aggregate Bond Index

90

Negative return

67
66

Loss more than 5%

30
46

Loss more than 10%

Loss more than 25%

16
1

10

Out of 457 total periods

S tart of period coincides with inception of Barclays U.S. Aggregate BondIndex.

Source: SPAR, FactSet Research Systems Inc.

JUNE 2015 / STRIKING A BALANCE

A balanced portfolio has historically moderated the degree

and frequency of losses an investor experiences relative to an
all-equity portfolio. Exhibit 4 illustrates how a balanced
portfolio lessened the number of occurrences of more
pronounced losses. MFS believes this historical moderation of
downside risk can help investors maintain discipline during
volatile markets.

The whole is greater than the sum of its parts

Conclusions

We previously looked at the long-term annualized returns

of stocks and bonds. Lets look now at the historical tradeoff
of returns and risks offered by stocks, bonds and a quarterly
rebalanced 60/40 mix. A common measure of the volatility
of returns, or risk, of different portfolios is standard
deviation. A lower standard deviation indicates less return
volatility.

The tendency of investors to be influenced by volatile

shifts in the markets is unlikely to change. However, a
portfolio of 60% stocks and 40% bonds rebalanced
quarterly has historically
helped bridge the significant periodic performance gaps
between stocks and bonds

Exhibit 5 plots the long-term annualized returns and standard

deviations of bonds and stocks and shows how the longterm outperformance of stocks has been accompanied by
greater return volatility.
 xhibit 5: Risk/Return profile for stocks, bonds
E
and a 60/40 mix

ANNUALIZED RETURN

A balanced portfolio has historically offered an attractive risk/reward

profile. January 1976 December 2014.
13%
Stocks
Risk 15.01 / Return 11.62%
12%
60/40
Risk 9.69 / Return 10.46%

11%

One might expect that a portfolio that combines stocks and

bonds would have a risk/reward profile that falls somewhere
between the two asset classes. However, because the returns
of stocks and bonds are not perfectly correlated, there are
diversification benefits from combining the asset classes,
resulting in an improved risk/return profile for a 60/40 mix. In
fact, historically the balanced portfolio captured 90% of the
return delivered by equities with only 65% of the volatility.1

moderated the downside risk and volatility associated

with an all-equity portfolio
delivered greater long-term returns than an all-bond
portfolio
offered the opportunity for improved risk-adjusted
performance
MFS believes the structure of this approach with the
associated diversification benefits can help investors address
the inherent uncertainty in the market and the natural
human tendency for emotions to drive investment decisions
often to the investors detriment.

10%
9%
8%
Bonds
Risk 5.46 / Return 7.86%
7%

10

12

14

16

18

ANNUALIZED STANDARD DEVIATION (RISK)

The start of the period coincides with the inception of Barclays U.S.
Aggregate Bond Index. Stocks (represented by S&P 500 Index).
Bonds (represented by Barclays U.S. Aggregate Bond Index).
Source: SPAR, FactSet Research Systems Inc. Standard deviation is an indicator
of the portfolios total return volatility, which is based on a minimum of 36
monthly returns. The larger the portfolios standard deviation, the greater the
portfolios volatility.

For the time period Jan. 1976 to Dec. 2014.

5

Keep in mind that all investments, including mutual funds, carry a certain amount of risk, including the possible loss of the principal amount
invested.
No investment strategy can guarantee a profit or protect against a loss.
Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, political,
regulatory, geopolitical, and other conditions.
Investments in debt instruments may decline in value as the result of declines in the credit quality of the issuer, borrower, counterparty,
underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more
sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually
fall), therefore the Funds share price may decline during rising rate environments as the underlying debt instruments in the portfolio adjust
to the rise in rates. Funds that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than
those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may
not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular
investment or type of investment at any particular time or at an acceptable price.
The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and
should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.
Before investing, consider the funds investment objectives, risks, charges, and expenses. For a prospectus or summary prospectus
containing this and other information, contact MFS or view online at mfs.com. Please read it carefully.
MFSE-BAL-WP-6/15
21828.7