When you invest in a balanced fund, you expect its manager to add value to your portfolio. In particular, you expect the manager to allocate your money among stocks, bonds and cash based upon the condition of the market. Nimble asset allocation should help to minimize your losses during bear markets and maximize your gains during bull markets — at least in theory.

The past year has provided an ideal test to see whether the balanced approach works in reality as well as in theory. By tracking how balanced funds weathered the recent ups and downs, we can asses whether they actually added value. Did their managers boost returns and reduce risk by adjusting their portfolios? Were these managers good at predicting which way the market would move next?

To find out, I examined the portfolio allocation of the largest 15 balanced funds in Canada that disclose this information. The funds that I scrutinized account for more than 44% of the $84 billion that Canadians have invested in balanced funds. Among them, these 15 funds reap close to $1 billion in management fees each year.

I compared the portfolios of the 15 funds at two points — the second quarter of 2008 versus the first quarter of 2009. The former was when Canadian equity values were peaking, right before the crash. The latter was when stocks were bottoming and getting ready to stage a 50% rally.

If balanced funds could have foreseen the future, they would have lightened up on stocks at the peak of the bull market and then jumped back into stocks before the recent low. This is presumably what you’re paying a balanced fund to do.

But it’s not at all what happened. The managers of these funds appear to have been asleep at the wheel. In fact, the data strongly suggest that balanced fund managers added hardly any value during the crisis. Contrary to public perception, those managers did not actively manage their asset allocation by moving from one investment category to another based on market factors. As you can see in Asleep at the wheel below, these fund managers barely budged their asset allocation, either at the recent peak or at the recent low.

The balanced funds that I examined seem to follow a very simple strategy. They stick to a stable asset allocation regardless of market direction. For example, if a balanced fund has decided that the best asset allocation is 45% stocks and 55% bonds and cash, it keeps to this split regardless of what happens in the market. If stocks plunge in price, reducing the value of the stocks below 45% of the fund’s total, the fund buys more stocks to bring its exposure back to 45% (and vice versa).

In general, there is nothing wrong with keeping to a fixed asset allocation. The strategy works because it forces you to add stocks when prices drop. It prods you in the opposite direction when stocks get expensive. In that case, a fixed allocation forces you to sell some of those overpriced stocks and buy bonds instead.

But you do not need to pay a balanced fund more than 2% a year in management fees to do something that anyone with a tad of discipline can do more cheaply.

Let’s imagine that five years ago you had placed 45% of your money in a low-cost equity index fund, 35% in a bond index fund, and the remainder in cash. Assume you rebalanced once a year to keep to those proportions. Following this simple strategy, you would have achieved an average annual return of roughly 5.1% and beat 90% of balanced funds. Not only that, but your bear market losses between June 2008 and February 2009 would have been around 18%, versus an average loss of 23.5% for balanced funds.