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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.

Fidelity Contrafund FCNTX continues to defy gravity as Will Danoff has consistently produced good results even as the total assets in this strategy top $100 billion.

Vanguard Capital Opportunity VHCOX has a Morning­star Analyst Rating of Gold and is closed to new investors. It was the total-return star, with returns that nearly doubled that of the Vanguard Growth Index. Great stock selection, especially in healthcare, has made this fund a winner.

Also noteworthy are great stock-pickers at American Funds AMCAP AMCPX and LKCM Equity LKEQX. These strategies vary in how cautious or aggressive they are, but it is the superior stock-picking that matters in the end.

As for the funds lagging the index fund, none are too far off, but Neutral-rated Marsico Focus MFOCX and American Century Growth TWCGX are near the back. Both have suffered from poor stock-selection. Marsico had the added problems of poor macro calls and high fees, making a tough trio of problems difficult to overcome.

Large Blend
Once again, quite a few funds beat the index funds in an area where few expect it. Attention to valuations and strong stock selection set the winners apart. Some of those winners were big investors in financials, meaning they were stalwarts in the 2000–02 bear market but lagged in the 2008–09 bear market.

Oakmark OAKMX and Oakmark Select OAKLX were the top performers on total return and risk-adjusted bases. Bill Nygren has had his ups and downs, as you’d expect from his focused portfolios, but the successes outweigh the failures by quite a bit.

One quality-focused fund slightly lagged, however. Dreyfus Appreciation DGAGX is a little behind Vanguard Total Stock Market Index VTSAX because it includes energy companies, whereas most of the other successful quality funds avoid commodity-like businesses.

Large Value
For value funds, the 2000-02 bear market was a cake­walk compared with 2008-09, which crushed many value funds that favored financials. Thus, you see great stock-pickers at the top, but this time under­weighting financials was the key to success.

Phil Davidson had the most impressive risk-adjusted performance at his two Silver-rated funds. American Century Equity Income TWEIX and American Century ValueTWVLX posted Sortino ratios of 1.21 and 0.92, respectively, versus 0.51 for Vanguard Value Index VVIAX. American Century Equity Income tones down equity risk with convertibles and preferreds, which also boost yields.

Fairholme FAIRX has had a nice rebound as financials have come roaring back in recent months. We don’t rate Auxier Focus AUXAX, but it is clear to see that holding a big cash stake has given the fund much less volatility than its peers and benchmark. Dodge & Cox Stock DODGX held down the next spot. Dodge & Cox Stock remains the same solid-value gem it was back in 2000, but had to overcome a bad 2008. Those who stayed with the fund have been rewarded.

Torray TORYX is our one laggard. The fund got burned on some financials and vulnerable cyclical stocks in the 2008-09 bear market. It has bounced around quite a bit from year to year, hurting risk-adjusted results.


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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