Top Funds for Nail-Biters
Over time, these funds have outshined their peers with fewer downswings.
Choppy markets can leave even the bravest investors feeling queasy about their bolder choices. Of course, investors have to be willing to take on some degree of risk to achieve results, but we were curious to see which funds have achieved strong long-term returns while assuming less risk than peers within their Morningstar categories.
To find some of the top funds in their respective categories with low risk scores, we began with the Morningstar Risk rating. This rating is one half of the Morningstar Risk-Adjusted Return measure, best known as the "star rating." The Risk rating looks at a fund's monthly returns compared with other funds in the category, and funds are penalized more for downside swings than for having much better returns than their peers. (This is because investors tend to be more sensitive to losing money than they are about earning big returns.) In each category, the 10% of funds with the lowest measured risk are dubbed Low Risk, the next 22.5% Below Average, the middle 35% Average, the next 22.5% Above Average, and the top 10% High. We arrive at Morningstar Return in a similar way. In combination, the Risk and Return ratings for the three-, five-, and 10-year periods produce each fund's star rating.
To find funds that have generated enviable long-term returns and that also sport below-average Morningstar risk ratings, we screened for managers with at least 10 years at the helm and who boast top quartile trailing 10-year records. Then, we required that the funds have low or below-average Morningstar Risk ratings. We also limited the list to funds that are open to new investments of $10,000 or less and to those with reasonable price tags.
To see the complete list, click here.
This screen pulled in a pretty solid group of 41 funds, representing all five mutual fund assets classes (domestic equity, international equity, balanced, taxable fixed income, and municipal bond). Of course, what makes one fund a lower-risk option within one peer group doesn't mean it's low-risk relative to options in other categories. That's why it's also important to keep absolute risk in mind.
Basically, the fixed-income and balanced funds (which own both stocks and bonds) have lower absolute risk compared with most of the equity funds, and especially compared with specialty funds. To demonstrate, looking back at every three-month period over the past 10 years, ultra-short bond fund DFA One-Year Fixed-Income's (DFIHX) worst three-month loss was 0.53% (from April 1 through June 30, 2004). The other extreme example from this list is Oppenheimer Gold & Special Minerals (OPGSX). In 1998, the fund lost 33.3% from the beginning of June through the end of August. This reflects the propensity for performance swings at this fund, as well as within its category. In general, the most volatile funds on our list are specialty or small-cap funds, whose returns are generally more dramatic than bond or balanced funds. That said, we'll highlight a few of these funds to give a flavor of how their managers have tamped down risk versus like-minded peers.
American Century Equity Income (TWEIX)
Phil Davidson has led this large-value offering since its 1994 inception. He and his analysts look for high-yielding stocks and combine them with a healthy stake of convertibles to try to create a portfolio that typically yields 2 percentage points more than the S&P 500 Index. Not surprisingly, this fund has pretty heavy stakes in energy, utilities, industrials, and financials, which tend to have higher yields. To illustrate Davidson's risk aversion, we'd point to his sales of Citigroup (C) and Freddie Mac (FRE) during the latter half of 2007. Realizing that the risks related to these firms' subprime exposure were greater than previously thought, he decided that they had become too risky for the portfolio and sold them at a loss. Financials aside, sticking with steady dividend-payers has made this fund a port in the storm. It probably won't shine in a growth-led market, but over the past 10 years, it has delivered some of the best returns in the large-value group.
FPA New Income (FPNIX)
Robert Rodriguez, who runs this fund and was named Morningstar Fixed-Income Manager of the Year in 2001, made an announcement in December 2007 that underscored his innate focus on risk. He announced that he would not buy any high-yield issues for this intermediate-term bond fund until the credit crisis subsides. He put the same halt on stock purchases for FPA Capital (FPPTX), a closed small-growth fund. As we now know, Rodriguez's buyer's strike demonstrated foresight because the credit crisis did indeed cause the market to tank. This call didn't come out of nowhere, though. Back in 2005, he was equally vocal in his concerns about the rise of undocumented mortgages and the strangely high credit ratings of risky mortgage securities. For now, the fund's buying halt and large cash stake have helped it hold up better than most peers. Rodriguez has long been a fierce defender of investors' capital--he has a 25-year streak of positive calendar-year returns.
Meridian Growth (MERDX)
This fund is a strong mid-cap growth option. Its manager, Rick Aster, has long employed a patient and prudent approach to growth investing. Basically, he looks for small- and mid-cap firms that are growing their earnings by at least 15% a year, but he doesn't try to shoot the lights out compared with other funds that hold faster-growing (and pricier) names. He is also more patient with his picks than most managers in the category, and long-term winners like American Tower Corporation (AMT) and Edwards Lifesciences Corporation (EW) have helped the fund move ahead of most peers during early 2008's market tumble. That said, we'd note that the fund won't look as great during a speculative rally, as was the case in 2007, but its consistently applied process and a low price tag have made this fund's long-term rewards great.
Morningstar.com Premium Members can run this screen themselves by clicking here. Not a Premium Member? You can still run this screen by taking a free, 14-day Premium Membership trial. (Note that the results may change as funds come in or drop out of the screen over time.)
Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.