If recent weeks are any indication, investors are feeling pretty panicky. Billions of dollars have left the market as stocks take a header into red-ink territory. But folks who flee the market now could be making a big mistake. Staying committed to your investments may become increasingly difficult in 2010's volatile market, but there are some safe havens out there.
To identify a handful of equity investments that have a historical record of protecting capital, I looked for mutual funds with a low downside capture ratio over the most recent three years, as provided by Morningstar. For example, a downside capture ratio of 75% means that the fund only experienced 75% of the downside that hit the broader market. Investors need to stay in the market to achieve long-term growth, but we all may have a greater need for downside protection, given that volatility will likely remain elevated. Here are three funds primed to both protect and grow capital in the near future:
American Century Equity-Income (TWEAX)
This fund invests primarily in stocks, but also throws in a smattering of convertible bonds to help boost income (currently about 14% of assets). Generating income is the primary focus for the management team here, although the fund has been no slouch when it comes to capital appreciation. Over the past decade and a half, Equity-Income has racked up a 9.2% annualized return, outranking 97% of all large-value funds. With a 67% downside capture ratio, expect this fund to avoid a good portion of any future downturn. Conversely, the fund won't shine in a bull market, but over the long-run, it has still outrun most of its peers.
Dividend-producing names are a big part of the portfolio here, including a decent overweight to the utility sector, which accounts for approximately 12% of assets. Management likes public utility holding company WGL Holdings
As a word of caution, turnover is high here, and the fund comes with an onerous front-end load, so Equity-Income is a good fund to own within a tax-advantaged qualified retirement plan where taxable events are minimized and where you can usually purchase the fund without paying the load fee.
FMI Large Cap (FMIHX)
It's not easy to avoid the worst of a market downturn with a portfolio made entirely of stocks, but the folks at FMI Large Cap have managed to do just that. The fund currently sports a 73% downside capture ratio as well as an impressive 89% upside capture ratio. Current favorites here include pharmaceutical distributor AmerisourceBergen
These names fit into the fund's overall search for companies with strong franchises, consistent revenues, and meaningful market shares that are selling below the team's fair value estimate. The fund has been around for less than nine years, but over the most recent five, FMI Large Cap has landed ahead of 98% of its competition. The fund did lose roughly 27% of its value in 2008's wild market, but that was still 10 percentage points better than the S&P 500. This fund is without a doubt an excellent long-term choice for fund investors who want to take a measured approach to equity investing.
Vanguard Dividend Appreciation ETF
If you're looking for a low-cost approach to defending your portfolio from the ravages of another downturn, look no further than this dividend-focused exchange-traded fund. Vanguard Dividend Appreciation comes with a rock-bottom 0.24% price tag and a downside capture ratio of just 73%. Because dividend-producing stocks are typically more stable and more resistant to economic maladies than their more growth-oriented counterparts, a portfolio of these stocks is likely to hold up better under gale-force market winds. The ETF is relatively new to the scene, but over its four-year life, it has outpaced the S&P 500 by more than two percentage points a year.
As might be expected, big-name dividend players like Coca-Cola
Low turnover and a well-diversified portfolio further add to the fund's many charms. Vanguard Dividend Appreciation ETF is a prime example of how investors don't have to spend a lot of money to both protect their capital and get a little investment income on the side.
Odds are good we're not out of the volatility woods just yet, so make sure your portfolio, and your temperament, are ready to endure some further sizeable market drops. These three funds can be a meaningful part of your toolkit to help defend your money against what promises to be a rough ride ahead.
For more insider investing and personal financial planning tips, check out the Fool's Rule Your Retirement service, which provides top-notch retirement and mutual fund advice. You can start your free 30-day trial today.
Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Coca-Cola is a Motley Fool Inside Value selection. AGL Resources, Johnson & Johnson, and Coca-Cola are Motley Fool Income Investor choices. Motley Fool Options has recommended buying calls on Johnson & Johnson. The Fool owns shares of Coca-Cola. The Fool has a disclosure policy.
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