Afraid of Bears? These Funds Keep an Eye on the Downside
For those afraid the market will take a turn for the worse, we offer a selection of Gold- and Silver-rated stock funds that have beaten their peers during downturns.
For a year that began so well for stocks--with a 12% first-quarter gain for the S&P 500--things have certainly turned around. Since reaching a recent closing high of 1419.04 April 2, the index has tumbled 7.1%, closing this past Friday at 1317.82.
The sluggish U.S. economic recovery gets some of the blame, but a fair share has to go to instability in Europe, where the ongoing sovereign debt crisis in Greece and elsewhere has cast dark clouds over what had been a robust start to the year for stocks. Right about now some investors surely are wondering if there's a bear creeping just over the investing horizon, ready to turn around what has been a strong three-year recovery from the lows of the 2008-09 financial crisis.
So could Europe's problems and other factors, such as ongoing high unemployment, hasten the arrival of a new bear market in stocks? Who knows? But at the very least the recent market downturn should give investors pause and get them to think about how a prolonged decline in the market would affect their portfolios.
To be clear, we are by no means predicting a bear market, but investors would do well to remember that the best defense against a true downturn is a portfolio that's well-diversified across asset classes--stocks as well as safer securities such as cash and bonds. For investors who want to stay in equities while factoring in downside protection just in case, we've identified domestic-stock funds that have track records of outperforming their peers in down markets. Morningstar measures this through a data point called bear market percentage, which ranks a fund's performance against its peers in all months over the previous five-year period in which the S&P 500 declined more than 3%. (For more on how we compute this statistic, click here.) The lower the percentile, the better the fund has performed in months the market declined. So a fund in the 5th percentile is far superior under such conditions to a fund in the 95th percentile. To find a fund's bear market percentile rank on Morningstar.com, click on the Ratings & Risk tab on the fund's cover page, scroll down to Volatility Measures, and click on the 5-Year tab. The rank appears at the end of the row with the fund's ticker symbol.
For our search we used Morningstar's Premium Fund Screener tool to look for funds in the top quartile in bear market rating for their categories. We stuck with no-load, noninstitutional funds and screened out those that are not accepting new customers. We also included only funds with Morningstar Analyst Ratings of Gold, Silver, or Bronze. Premium users can see the full results here. Below is a closer look at three funds on the list.
FMI Large Cap (FMIHX)
Bear Market Percentile Rank: 22
This large-blend fund outperformed the market during both the downturn of 2008 (when the fund lost 26.9%, which, while painful, still beat a 37.0% loss for the S&P 500) and during the start of the rebound in 2009 (29.7% return versus 26.5% for the S&P 500). Its one- and three-year annualized returns have been middle-of-the–pack for the large-blend category, but its five- and 10-year records are both in the top 5%. The managers run a concentrated portfolio of companies with sturdy, sensible business models and recurring revenues. This process often leads them to more defensive stocks, such as Wal-Mart Stories (WMT) and Kimberly-Clark (KMB). About 11% of holdings are outside the United States, which is double the category average. Morningstar analyst Kathryn Young calls the fund a "topnotch choice" and applauds its versatility.
Amana Trust Income (AMANX)
Bear Market Percentile Rank: 12
In keeping with its roots as a fund designed for Muslim investors, this large-blend offering, like sibling Amana Trust Growth (AMAGX), avoids stocks that get more than 5% of their revenues from activities that violate Islamic law. This includes stocks related to alcohol, tobacco, gambling, pornography, pork, and paying or receiving interest. The last of these prohibitions means the fund avoids financial-services stocks, which, in 2008, turned out to be a good idea and helped limit the fund's loss to 23.5%, beating its category average by more than 14 points. Manager Nick Kaiser looks for stocks that pay dividends and are attractively priced, holding them for the long term. Turnover is just 3%. The fund is overweight in industrials stocks (27.5% of the portfolio versus 12.8% for the category) while underweight in the technology sector (9.1% versus 17.8%). Nearly 20% of the portfolio is in non-U.S. stocks while another 11% is in cash. Fees are a little high for the category at 1.2%.
Vanguard Dividend Growth (VDIGX)
Bear Market Percentile Rank: 18
A favorite among Morningstar readers and a popular choice among investors looking for a fund steeped in quality dividend payers, this fund also happens to have a strong bear-market record. Its 25.6% loss in 2008 put it in the best-performing 3% of all large-blend funds for the year, while its top-decile annualized returns for the trailing one-, five-, and 10-year periods show good short- and long-term performance. The fund invests in companies with proven track records of, or strong potential for, dividend growth. The result is a portfolio with many big, wide-moat names, such as Johnson & Johnson (JNJ), Microsoft (MSFT), and
ExxonMobil (XOM), which tend to hold up better than smaller, less moat-worthy names during market downturns. The fund's low 0.31% expense ratio, at less than half the category average, is also a major advantage.
Portfolio information as of March 31 for FMI Large Cap and Vanguard Dividend Growth and as of April 30 for Amana Trust Income; all performance data as of May 25.
Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.