• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Investment Insights>Keep an Eye on the Downside

Related Content

  1. Videos
  2. Articles
  1. Morningstar's Guide to College Planning

    Get the facts on the high cost of higher education, college-savings strategies, 529 plans, financial aid, and student loans in this special web seminar hosted by Morningstar's Adam Zoll.

  2. GMO's Sobering Forecast for Stock and Bond Returns

    U.S. stocks, particularly small caps, and bonds look unattractive overall, but low-double-digit nominal returns are possible for emerging-markets value stocks, says GMO's Ben Inker.

  3. Are Investors Still Late to the Party?

    The gap between investor returns and average fund returns persists across most asset classes--but there is a bright spot, says Morningstar's Russ Kinnel.

  4. Retirement Planning in Overvalued Markets

    Ratcheting down your equity exposure when stocks are richly valued can help combat 'sequence of return' risk and improve retirement-income sustainability, says financial-planning expert Michael Kitces.

Keep an Eye on the Downside

Funds for the cautious investor.

Russel Kinnel, 02/24/2015

It's been quite a while since the last bear market. So this is a fine time to check in on fund downside--specifically, the downside capture ratio.

This measure tells you how much of an index's losses are captured by a fund. Say the S&P 500 loses 10%. A fund that lost 12.5% over the same period would have downside capture of 125%. One that lost 7.5% has downside capture of 75%.

That differs from Morningstar Risk in two key ways. First, the Morningstar Risk rating is relative to a fund's Morningstar Category, whereas downside capture is relative to a broad index such as the S&P 500, MSCI EAFE, or Barclays U.S. Aggregate Bond indexes. The further a fund's portfolio diverges from from those indexes, the less helpful the downside capture measure is.

Second, Morningstar Risk looks at volatility in both directions, though it penalizes losses more, whereas downside capture tells you only about the red ink. The reason Morningstar Risk takes a more holistic view is that volatility on the upside can often later mean volatility on the downside.

For this article, I sought funds with low 10-year downside capture ratios in order to find some lower-risk funds. Five-year measures wouldn't include the 2008 bear market. I also selected funds in categories where those broad benchmarks are good fits: U.S. large-cap equities, foreign large-cap equities, and intermediate bonds. To ensure I was on the right path, I screened out funds that had high Morningstar Risk and funds that were not Morningstar Medalists. I included funds closed to new investors because those who own the funds still need to decide whether to keep them.

Foreign Large Caps
First Eagle Overseas SGOVX (50% downside capture ratio) is a name that comes up just about any time you mention low-risk foreign funds. Through a few manager transitions, the fund has stayed true to its mandate of protecting against losses while still growing principal. The fund's losses in 2008 were half the category's. Management aims to reduce risk by finding good companies trading at sizable discounts to their intrinsic value estimate. They also hold cash and gold-mining stocks when the markets look frothy or inflation looks threatening. (I thought they always hold gold.) I worry about management being taxed by a big asset base at a time when comanager Abhay Deshpande has departed. However, with a 22% cash position and 10% in gold, the fund is still a good bet to lose less in the next down market. This fund is closed to new investors, but First Eagle Global SGENX is open and run in a similarly risk-averse way.

Tweedy, Browne Global Value TBGVX (54% downside capture ratio) also employs a value-conscious approach with an emphasis on healthy balance sheets. The fund avoids big individual stock bets, and its currency hedging also reduces volatility. The style here is modeled on Warren Buffett's idea of paying a fair price for a great company such as Nestle NSRGY.

Artisan International Value ARTKX (70% downside capture ratio) continues to look like a keeper for those who got in before it closed. David Samra and Dan O'Keefe hate high valuations and lousy balance sheets, and it shows.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

©2017 Morningstar Advisor. All right reserved.