High equity prices mean you might want to get conservative.
This article was published in the August 2016 issue of Morningstar FundInvestor.Download a complimentary copy of FundInvestor by visiting the website.
In the spring, I wrote on the FundInvestor blog that we faced “The Summer of Our Discontent.” I mentioned the Brexit vote in the blog, but then Britain actually voted for it. This, plus the coup attempt in Turkey, has made for a volatile summer.
Yet the U.S. stock market is currently hitting new highs. True, Europe has been hit hard, especially when you consider the currency losses.
So, we have turbulence, high U.S. equity prices, and low bond yields everywhere. Sounds like a decent time to play defense. With that in mind, I’ve pulled five funds that play very different kinds of defense.
Moving a lot of money to cash isn’t necessarily the safest bet; if your timing is off, you’ll fall behind. Instead, consider something that offers upside potential to go with downside protection.
FPA New Income FPNIX always plays defense. Always. It’s wary of interest-rate risk, credit risk, and probably open spaces and the number 13. So, it ought to hold up well in just about any calamity. If, however, we get blue skies and happy times, it will likely lag most bond funds. Tom Atteberry aims to have positive absolute returns through thick and thin. To do that, he puts most of the portfolio in high-quality bonds, though he reserves a slot for riskier stuff. That gives the fund a modest yield but robust defense.
Gateway GATEX takes another route to steadier returns. The fund holds a S&P 500-like portfolio, then sells index call options and buys index puts that are out of the money. The hedging gives the fund much less downside and upside than the stock market. It managed positive gains in tough years like 2011 and 2015, and while it lost nearly 14% in 2008, that still left it well ahead of the S&P 500. On the other hand, it gained only 8.4% in 2013, compared with the benchmark’s 32.4%. So, yes, you are giving up a lot of upside.
First Eagle Overseas SGOVX, which has a Morningstar Analyst Rating of Bronze, has greater risk and return compared with the above two, but compared with foreign large-blend funds, it’s still quite conservative. Management aims to preserve capital by owning gold, cash, and stocks trading at a significant discount to intrinsic value. The result has been a tremendous risk/reward profile over the long haul, though current managers don’t own the whole record. The strategy and early record were of Jean-Marie Eveillard’s devising, but the current managers came on board in 2008 and 2010. Fortunately, performance has remained strong even with a continued emphasis on defense.
Matthews Asia Dividend MAPIX tones down the risk of investing in Asia by focusing on dividend payers. That means investing in more-mature businesses with healthy balance sheets, which has really made the fund stand out in the diversified Pacific/Asia Morningstar Category. The fund has pummeled its peer group since it was launched and landed in the top 5% of the category in the brutal years of 2008 and 2011. Comanagers Yu Zhang and Robert Horrocks have done a fine job looking for dividend payers with stable cash flows and solid franchises. The fund has a hefty Japan weighting with names like Japan Tobacco, Bridgestone, and Hoya, and Japan is a more mature market than most of the rest of Asia.
American Century Equity Income TWEIX also looks for dividends, and a slug of bonds and cash give it added defense. Phil Davidson is the longest-tenured manager listed here. His tenure goes back to 1994, and the strategy has worked nicely year in and year out. The bond stake, which includes convertibles, has generally ranged from 15% to 25%, and that gives the fund a more defensive posture than most equity-income funds. Yes, the fund will lag in big rallies like 2009, but it provides a much smoother ride and still strong long-term returns.