With stocks plunging one day and soaring the next, one question seems to be foremost on the minds of many investors: When the market finally makes up its mind, in which direction will it move? Naturally, some believe that the painful month of May was merely a temporary speed bump for the markets, while others are convinced that the next bear market is right around the corner.
As for me, I can definitively say -- in the immortal words of Jeff Spicoli from Fast Times at Ridgemont High -- "I don't know." Making bold market calls is not one of my hidden talents -- nor do I believe it is an integral component of investing success.
There are too many potential obstacles waiting to trip up the market for it not to stumble on at least one of them. Inflationary pressures might creep higher, consumers could finally tighten their spending, the Fed might overshoot on interest rates and bring economic growth to a standstill, etc., etc., on and on.
While I doubt we're headed for a stagflationary quagmire, it never hurts to be prepared for a sluggish market. With that in mind, I've been on the lookout for defensive mutual funds that are likely to escape a market downturn relatively unscathed.
The recipe for a bear killer
To begin my search, I first crossed small-cap funds off my list. While smaller companies are typically market leaders when times are good, they tend to struggle when the economy is in a tailspin.
Furthermore, the small-cap sector has enjoyed a powerful surge in recent years, and it's long overdue for a breather. Since January 2005, the Russell 2000 index has delivered a gain of 19.5%, nearly doubling the 10.6% return of the S&P 500. In a tumbling market, money will likely rotate out of small caps and flow into the relative shelter of larger, more established companies. That pattern already began playing out last month, with the Russell 2000 giving back 5.7%, versus a decline of just 3.1% for the S&P.
Next, I also decided to eliminate bond funds from consideration (too easy), as well as sector funds (too difficult).
From there, I ruled out anything that carried an above-average expense ratio. Overpaying for a fund is bad enough when the market is up 10%, but it's even harder to stomach when it's down 10%. I also looked past funds with high R-Squared figures (index huggers), inexperienced management teams, or excessively volatile track records.
Finally, and most importantly, I wanted to zoom in on those select few battle-tested funds that have a proven ability to stay afloat when others are sinking. Therefore, I screened for funds that landed in the top 10% of their category during the market decline of 2000. That could just be a fluke, you say. Possibly. So I also looked for funds that repeated that impressive performance the following year . and again the year after that.
The finalists at a glance
|
Fund |
2000 Return |
2001 Return |
2002 Return |
Expense Ratio |
|---|---|---|---|---|
|
American Century Equity Income |
+21.9% (9%)* |
+11.3% (4%) |
-5.0% (1%) |
0.98% |
|
American Funds Balanced |
+15.9% (6%) |
+8.2% (3%) |
-6.3% (8%) |
0.59% |
|
Clipper Fund |
+37.4% (2%) |
+10.3% (5%) |
-5.5% (1%) |
1.11%** |
|
Oakmark Global |
+15.8% (2%) |
+20.1% (1%) |
-2.1% (3%) |
1.20% |
**Will be dropping sharply as of this year.
American Century Equity Income (TWEIX)
As the name implies, this fund targets dividend-paying stocks, though it has also boosted its yield (which currently stands at 2.1%) by adding a slug of preferred stocks and convertible bonds. With the bulk of its assets tied up in low-risk utilities and high-yielding giants like ExxonMobil
Over the past decade, the fund has racked up annual returns of 12.1%, cruising past the S&P 500 and outpacing more than 97% of its peer group.
American Funds American Balanced 'A' (ABALX)
Despite a hefty front-end load, this inexpensive fund (expense ratio is roughly half of the category average) was among the industry's earliest "all-weather" balanced funds -- and it remains one of the best around.
Shareholders can rest easy knowing that roughly 16% of the portfolio is sunk in secure government and AAA-rated corporate bonds, while the remainder is primarily invested in the bluest of blue chips -- with top holdings such as Microsoft
Over the past two decades, American Funds Balanced has delivered positive total returns in all but two calendar years (down 1.6% in 1990 and 6.3% in 2002). For all its stability, though, the fund can still pack a punch. From January 1986 through March 2006, a $10,000 investment would have grown to more than $83,000 -- for an impressive 11.1% annual growth rate (not including the front-end fee).
Clipper Fund (CFIMX)
Whenever a new manager takes the helm, prior performance can usually be thrown out the window. In this case, though, an already solid fund now has the opportunity to be outstanding.
Incoming managers Chris Davis and Ken Feinberg -- who were brought on board earlier this year -- have been putting up big numbers at the highly respected Davis NY Venture Fund (NYVTX) for more than a decade. As an added incentive, this looks like a case study in strong corporate governance; the incoming management team has voluntarily decided to slash expenses and "eat their own cooking" -- committing to plunk down $50 million of their own money in the fund.
Despite a relatively concentrated portfolio of around two dozen positions, Clipper should sail smoothly even in the roughest of seas. The buy-and-hold managers focus on financially strong companies with sustainable competitive advantages, and have essentially doubled up on proven leaders like Johnson & Johnson
The results speak for themselves: NY Venture has posted top-decile performance over the trailing three-, five-, and 10-year periods, along with muted volatility and stellar tax-efficiency. Shareholders of Clipper can expect more of the same.
Oakmark Global (OAKGX)
Like most in its peer group, Oakmark Global favors well-known foreign leaders like pharmaceutical giant GlaxoSmithKline
Though its track record is relatively short, the results to date have been top-notch. Since inception in 1999, Oakmark Global has quite simply been one of the best funds the global category has to offer. It has only recorded one down year over that span, and its trailing five-year return of 16.3% trounces its benchmark by more than 800 basis points and ranks No. 1 out of 308 competitors.
The common denominator
When surveying funds that have made it to the top of the charts over the long term, more often than not, bear-market survival got them there. While huge advances in an up market are nice, it is usually far more important to limit losses in a down market.
None of the funds listed above is particularly flashy, but they have all been able to successfully navigate prior market downturns and avoid undue losses -- towering over their competition in the process.
Not surprisingly, many of the virtues shared by this elite group -- strong long-term track records, seasoned managers, below-average expenses, and shareholder-friendly policies -- are the same prerequisites that Shannon Zimmerman demands when searching for outstanding funds in his Motley Fool Champion Funds service.
Shannon's lineup of recommended funds is beating the S&P 500 by more than nine percentage points on average. And with in-depth analysis and color commentary on more than 40 of the fund industry's standout performers, Champion Funds is chock-full of additional ideas to help you withstand the next bear market (or run with the next bull) -- and a free trial won't cost you a dime. Now that's what I call capital preservation.
Fool contributor Nathan Slaughter owns shares of American Funds American Balanced Fund, but none of the stocks mentioned. Johnson & Johnson, GlaxoSmithKline, and Diageo are Income Investor picks. Microsoft is an Inside Value pick. The Fool has a disclosure policy.
