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Asset Allocation, Portfolio Rebalancing a Billion-Dollar Hit

In the wake of the three-year bear market that has seen stocks drop almost 50%, two mutual fund groups say they are successfully attracting hundreds of millions of assets by automatically rebalance diversified portfolios.

A third group, the Franklin group of funds, is considering a similar asset-allocation and rebalancing program, but was unavailable for comment.

Nearly Half a Billion

OppenheimerFunds of New York reports that since June 2001, its "Portfolio Builder" program has pulled in more than $450 million in assets.

Under the program, which is offered at no extra charge, investors have a choice of five different time horizons in which to invest. Within each time horizon, there are three asset-allocation portfolios, each based on the investor's tolerance for risk. Investors, with the help of financial advisers, choose from the selection of asset mixes, and put their money in Oppenheimer funds. The portfolios can be automatically rebalanced quarterly, semiannually, annually or whenever the client needs to make changes.

Meanwhile, MFS Investment Management, Boston, says it has attracted $400 million in assets since the June 2002 launch of its rebalancing program, which is quite different from Oppenheimer's.

MFS created four separate funds-of-funds, each with a different asset-allocation mix. The conservative fund of funds, for example, invests 35% in U.S. stock funds and 5% in international stock funds, based on investment style, 10% in cash and the rest in bonds.

MFS charges 10 basis points for each fund-of-funds to recoup operational expenses. Rebalancing is daily, based on cash flows. It also is based on quarterly performance and extreme market movements.

"We've been pleased about the response," says David Connelly, VP, director of product management at MFS Investment Management, Boston. "We exceeded expectations. The message has been resonating that [asset allocation and portfolio rebalancing] enforces a disciplined way to invest."

Financial research shows that these fund groups may be on target. Asset-allocation and portfolio rebalancing help reduce the risk of financial market losses, according to a study by Ibbotson Associates, Chicago. Over the past 25 years, the study indicated, rebalancing to a steady 60% stock/40% bond mix at least annually reduced portfolio risk by 25%. Rebalancing delivered a higher return per unit of risk compared with an unbalanced portfolio.

Research published in the Financial Analyst Journal also shows that 93.6% of a portfolio's return is due to asset allocation. Plus, the asset-allocation mix determines about 94% of the variance in a portfolio. So, a portfolio of bonds and stock funds with different investment styles can produce less-volatile performance over the long term.

Half a Billion More

Oppenheimer's program is a big hit, said Tricia Scarlatta, product manager. The fund group has pulled in almost $500 million in new business. Most of the money is going into tax-deferred retirement accounts. And the average account size is $80,000.

Scarlatta said an Oppenheimer survey of registered representatives prior to the product development stage in 2001 revealed a large demand for portfolio rebalancing. Advisers wanted to offer the service to clients with lower net worths than those who use wrap accounts. The Oppenheimer service presented an extra free benefit for their clients. Oppenheimer already had been involved with the profitable wrap account business. So it was an easy transition to offer it on its own funds.

"In a bad year, we brought in a lot of money," Scarlatta said. "It enables reps to offer their clients enhanced services at no additional cost. It took the burden off of the financial adviser because Oppenheimer does the rebalancing, produces performance reports and generates consolidated statements."

There are several vendors that provide asset-allocation and portfolio rebalancing services to institutional investors. AdvisorPort and SEI are two of the biggest players. Nevertheless, both MFS and Oppenheimer developed their rebalancing platforms in-house. The reason: It is easier to control costs.

"It was very expensive to develop," Scarlotta says. "But it is profitable."

Both Scarlatta and Connelly agree that a healthy mix of wirehouse brokers and financial planners who clear through major broker/dealers are using the fund groups' rebalancing programs.

Meanwhile financial advisers say that the service is long overdue, but there are drawbacks.

Harold Evensky, a Coral Gables, Fla. financial planner and author of Wealth Management, The Financial Advisor's Guide to Investing and Managing Client Assets (McGraw-Hill), favors the service.

He said that the automatic portfolio-rebalancing programs offered by fund groups help reduce investors' risks. But it is important for the financial adviser to set up the correct parameters.

"You get a higher total return by not rebalancing, but investors will have too much in equities," Evensky said. "Rebalancing helps people achieve their goals with less risk."

Although commission-based financial advisers may choose to stick with one fund group's rebalancing services, Evensky said that many financial planners prefer to invest in a wide range of funds from different fund groups. This way, they can pick the best funds among the entire universe of funds.

As Evensky noted, "A single fund group can't offer all the best funds."

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