Few episodes in stock market history have equaled the decimation in financial stocks over the past two years. With repeating cycles of bad news, government action, and hopes first discovered and then dashed, investors of all kinds have seen losses they never would have imagined from companies that used to carry blue-chip reputations.

But with the latest bounce from March's lows, financials have come roaring back. Citigroup (NYSE:C) and AIG (NYSE:AIG) are both up more than 200% from the levels they hit hardly a month ago, while healthier institutions like Goldman Sachs (NYSE:GS) have started contemplating how to repay the federal government and get back to business as usual.

Will the latest optimism about financial stocks give way to another sobering decline? Or is this bounce for real?

What the funds think
That's the question that Foolish fund expert Amanda Kish asked in her latest update for subscribers to her Motley Fool Champion Funds newsletter. The issue is especially relevant for mutual fund investors, because so many funds got ensnared by the financial crisis.

Even experts fell into the value trap. Bill Miller, for instance, of Legg Mason Value Trust (LMVTX) fame, is best known for his fund's 15-year streak of outperforming the S&P 500. Yet more recently, big bets on AIG and Freddie Mac backfired, and while Miller may finally be benefiting from his continuing holdings in State Street (NYSE:STT) and JPMorgan Chase (NYSE:JPM) as they recover from 52-week lows, the fund is still down so far this year.

Although you always hope that your fund managers will simply avoid all the pitfalls the market throws at them, one mark of truly outstanding fund management is how they deal with the inevitable mistakes they make. Sometimes, stubbornly sticking to your strategy pays off in the long run -- but other times, it can cost your investors everything.

Different answers for different investors
Perhaps the most illuminating aspect of Amanda's analysis is in the vastly different ways that each of the four funds she looks at is dealing with the financial crisis. Consider these diverse ways of handling the situation:

  • One fund sold off the majority of its bank stocks. But rather than giving up on the financial sector entirely, the fund bought into insurance companies like Prudential (NYSE:PRU). Although the strategy hasn't worked to date, it's a good example of how replacing your losers with better stocks can work well -- if you can find those better stocks in the first place.
  • Another fund has moved away from large-cap financials in favor of smaller banks, which have held up better. In addition, niche financial companies like mortgage insurer MBIA (NYSE:MBI) have recovered this year, and the fund's global approach could create gains even if the U.S. continues to suffer disproportionately from the crisis.
  • A third fund has been conservative throughout the bear market, with a healthy cash position. As a result, it hasn't made any big moves, and probably will stick to its guns in the future as well.
  • Lastly, one small-cap fund is actually thankful for its financial exposure, as it helped the fund outperform its benchmark last year. Its success will hinge on whether smaller financials can withstand the economic downturn as well as they have.

All in all, even though each of these funds has taken a different tack toward dealing with the problems within the financial sector, they've all done something -- and that's exactly what you want from the managers you pay to oversee your portfolio.

Find out more
If you're not seeing the same kind of response from your mutual funds, then maybe you're not investing in the right funds. If you're curious about which funds Amanda is recommending -- or you just want to know more about what those funds are doing right now -- then take advantage of our special offer for a free look at our Champion Funds newsletter. For 30 days, you'll get access to everything our paid subscribers see, including current and past newsletters, fund recommendations, and much more.

You can learn a lot about how to deal with tough situations by watching how good fund managers respond to them. If you find professionals who make smart moves, you just may discover a secret that will lead to outsized returns in the years to come.

For more on dealing with the market mess, read this:

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Fool contributor Dan Caplinger has thus far steered clear of financials, both up and down. He doesn't own shares of the companies mentioned. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy knows what to do.