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8 Relatively Low-Risk Equity Funds

These mutual funds lost the least in the bear market.

Russel Kinnel, 03/07/2017

After my column on low-risk bond funds, some folks asked me to do the same exercise with equity funds. Once again, I ran 10-year maximum drawdowns for Morningstar 500 equity funds, and I'll highlight those with the lowest figures below.

As you can see, even a lower-risk stock fund has plenty of risk. The bond funds I wrote about had minuscule losses, whereas these funds lost more than 30% from peak to trough. The 2007-09 bear market hammered equities of all kinds, so that even the most-cautious funds suffered big downdrafts. This is why I used the word "relatively" to modify "low risk." All equities and equity funds have risk. For benchmark purposes, keep in mind that S&P 500 funds' max drawdown was just above 50%, so losses in the 30% area were a huge improvement.

A second caveat is that while max drawdown is probably the best measure of past risk in a bond fund, volatility measures are of equal merit to max drawdown for stock funds. The reason is that volatility is a pretty good predictor of future losses--not because I think that volatility is the same thing as risk. And we have more time periods in which to measure volatility rather than one big bear market. When you look at a stock fund's risk profile, max drawdown is helpful, but so are volatility measures such as standard deviation, Morningstar Risk, and downside capture, which is really partly about volatility and partly about actual losses.

We expect to add max drawdown to fund data pages later this year, so stay tuned.

My final caveat is that the next bear market will be different from the previous one, so max drawdown will not be a perfect match with the next bear market. As Kevin McDevitt and I have pointed out, each bear market hits sectors and parts of the Morningstar Style Box differently.

The max drawdown for Franklin Mutual Global Discovery TEDIX, which has a Morningstar Analyst Rating of Silver, is 31.48%, owing to a cautious value-driven strategy. Lead manager Peter Langerman avoids price risk by investing in cheap companies, and he reduces equity risk a bit by venturing into distressed debt and holding more cash than his competition in most years. Historically, Mutual Series has lost less in downturns at the cost of upside in rallies. However, I wouldn't expect it to hold up quite as well in the next downturn. In the 2007-09 bear market, previous managers Anne Gudefin and Charles Lahr grew cautious and raised cash throughout the downturn and into the recovery. They took cash from 30% to over 50% in 2009. That was great for the fund's defense, but by raising cash in 2009 even as stocks got cheap, they missed out on a good deal of the rebound. Since then, Mutual Series has decided against such big cash moves, and Langerman and team have kept cash in the 5%-15% range.

First Eagle Overseas SGOVX limited losses to 32.13% in the bear market, owing to a fairly comprehensive approach to capital preservation as the fund held cash, gold bullion, bonds, and cheap stocks. That approach continues today as the closed fund is only about 70% invested in equities. While the strategy hasn't changed, the managers have. Founder and architect of the strategy Jean-Marie Eveillard re-retired in March 2009, and comanager Abhay Deshpande left in 2014. However, Matt McLennan (who became a manager in September 2008) and Kimball Brooker (who was named a manager in 2010) have done a fine job executing the strategy since then.

Gold-rated Vanguard Health Care VGHCX lost just 33.00% in the bear market owing to the defensive nature of large-cap pharmaceutical stocks and the skill of Ed Owens and the Wellington team. Owens later passed the baton to Jean Hynes, who has kept the strategy intact. Unlike the above two funds, this one boasts a very low expense ratio, which also serves to reduce losses in a bear market.

The closed American Century Equity Income TWEIX lost 34.35% from peak to trough as Phil Davidson's cautious approach spared shareholders from the worst of the bear market. Besides owning relatively defensive dividend-paying stocks, Davidson holds a chunk of convertibles, preferrreds, and cash. An emphasis on income can fall prey to value traps, which this Silver-rated fund seeks to avoid by emphasizing high returns on capital and stable revenues. It was a shareholder-friendly move to close the fund to new investors in October 2016.

Royce Special Equity RYSEX held losses to 34.55% in the bear market through a mix of valuation sensitivity and a tremendous focus on accounting issues. It's the latter that makes the Silver-rated fund stand out and the reason it's one of my favorites. Charlie Dreifus looks for clean accounting and ferrets out red flags like no one else. In good times, those red flags might not be reflected in a company's stock price, but they can signal greater problems that get unearthed in recessions.

Bronze-rated Amana Income AMANX limited losses to 34.70% because it avoids financials. The Shariah-compliant fund can't own companies that lend money, and that worked wonderfully in the last bear market since financials were the worst place to be. However, if the next bear market hits a different sector, this fund might not hold up quite as well. True, it has overweightings in defensive sectors like healthcare and consumer defensive, but it also has big overweightings in industrials and basic materials. To my eye, this fund isn't quite as defensive as the rest covered here.

Franklin Utilities FKUTX shed 35.15% from peak to trough. You'd expect regulated utilities to lose less in a downturn, and that's what happened in this fund's case. Manager John Kohli runs the fund as a traditional utilities fund with a focus on U.S. regulated utilities, whereas many peers chase the income of energy and telecommunications names, which are more vulnerable to a downturn.

Silver-rated atthews Asia Dividend MAPIX lost just 35.21% in the bear market. I bet you didn't expect an emerging-markets fund to pop up on this list. Yet, its dividend emphasis has proved to be a real lifesaver in down markets. It means the fund is in more-dependable companies while its peers may be more focused on the next big thing. I've owned this fund for a long time, and it continues to offer some of the best risk/reward values in emerging markets.

For those of you who didn't start investing until after the bear market, it may be sobering to hear that a 32% drawdown counted as outstanding, but that's why defense is important. It's also noteworthy that many of these funds are not in the large-cap U.S. categories that most associate with safety. I don't think foreign equities are necessarily riskier than U.S. stocks, and that's especially true today when U.S. equities have appreciated more since the bear market than non-U.S. ones.

The funds here also show that active management can do a good job of adding value by paring losses in a downturn. While talking about bear markets isn't exactly a marketer's dream, skilled managers really can help with a sound capital-preservation strategy. 


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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