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Stress-Testing Funds Through Two Bear Markets and Two Bull Markets

Looking at performance since 2000 creates a better picture of which funds have delivered for investors. 

Russel Kinnel, 12/08/2016

The 2008–09 bear market made a bonfire of financials stocks, but all the other sectors were hit fairly hard, too. In contrast, the 2000–02 bear market crushed tech stocks, but other areas held up fairly well.

Let’s look at what those bear markets tell us about some fund managers. The 2000–02 bear market has fallen out of the standard trailing return figures now, so I thought, “Why not add it back in?” We now have two big bear markets and two ensuing rallies to measure when we go back to March 2000, and I was curious to see which funds look best when viewed through that broad lens.

I only wanted active managers from the Morningstar 500 who were there at the beginning of that first bear market. I looked at funds by Morningstar Category versus an index fund on a total-return basis and on a risk-adjusted basis as measured by the Sortino ratio. Sortino isn’t too different from the Morningstar Rating for funds, but it does allow custom time periods whereas the star rating stops at 10 years.

What emerged is a better picture of funds that have delivered for investors over full market cycles. To be sure, there are no guarantees that past is prologue, but some solid funds rose to the top while others failed to keep up with a comparable index fund. For many, the path to better risk-adjusted returns was through superior risk-reduction rather than high returns, and that’s worth remembering this long into the current market rally.

Because I am focusing on funds with manager tenure over the whole period, I am skewing results to the positive side as poor-performing managers are more likely to have been fired. But I think this is a revealing look at those fund managers who have had the longevity to stick around.

Large Growth
So few large-growth funds are beating their bench­mark lately that it is truly striking to see how many have beaten the Vanguard Growth Index VIGAX over this time period. (Again, there’s a skew here when you limit the field to manager tenure going back to 2000.) One key part to that story is that the earlier bear market was a perfect storm for large growth in general and large-growth indexes in particular. The indexes are market-cap-weighted, and when you have an extreme growth rally like we saw in the late 1990s, that can mean that large-growth indexes skew heavily to overpriced growth stocks. The ensuing early 2000s' bear market was pretty much the opposite of the current environment, when a few names have dominated performance in a way that’s made the benchmark very tough to beat.

The common theme among the funds that have beaten the index by a significant margin is fundamentals. All of these funds stayed focused on deep research on company fundamentals, including valuation, and that helped stock-picking shine through. On the other hand, funds that chased hot trends or ignored valuation got crushed.

Jensen Quality Growth JENSX had the highest Sortino ratio from March 2000 through November 2016 thanks to its emphasis on high-quality stocks. These stocks tend to be well-known brand names with significant barriers to entry, which makes them less volatile and helps them hold up in recessions.

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.

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