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Big Funds that Avoided Troubled Financials

Which mutual funds have managed to sidestep the carnage?

David Kathman, 09/30/2008

The past few weeks have been among the most dramatic in the history of Wall Street, reshaping the financial industry in fundamental ways. The federal government placed mortgage giants Fannie Mae FNM and Freddie Mac FRE in conservatorship and took effective control of insurance giant AIG AIG with an $85 billion loan. Of the four big investment banks remaining after the collapse of Bear Stearns, Lehman Brothers is now bankrupt, Merrill Lynch MER is being bought by Bank of America BAC, and Goldman Sachs GS and Morgan Stanley MS are morphing into bank holding companies, subjecting themselves to greater capital requirements and regulatory oversight. All this has resulted in the Treasury Department proposing a $700 billion bailout designed to keep the economy from grinding to a halt.

As the crisis has unfolded, we've been looking at how the battered stocks of these Wall Street giants are affecting mutual fund investors. What about funds that have avoided the whole mess? We thought it would be interesting to look at funds whose most recent portfolio did not include any of the seven troubled giants: Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Merrill Lynch, Goldman Sachs, or Morgan Stanley. Any such list is somewhat arbitrary, as there are plenty of financial stocks that have also been punished badly, but this one is sort of a mirror image of our lists of funds with the biggest exposure to those same seven stocks.PAGEBREAK

Even if we limit ourselves to diversified large-cap funds, there are almost 600 funds with no investment in the seven stocks. The following table shows the 10 largest, with each fund's category, the size of its asset base, the date of its most recent portfolio, its year-to-date return as of September 25, and its percentile ranking within its category.

 Biggest Large-Cap Funds with No Exposure
 

Category

Size
($Mil)
Portfolio
Date
Return
TYD
% Rank
Cat YTD
Vanguard Growth Index VIGRX
Large Growth
16,598.3 06-30-08 -16.76 19
Calamous Growth CVGRX
Large Growth
13,060.5 06-30-08 -26.41 94
Longleaf Partners LLPFX
Large Blend
12,096.0 06-30-08 -21.65 85
GMO U.S. Quality Equity III GQETX
Large Blend
10,045.3 05-31-08 -12.96 6
Fairholme Fund FAIRX
Large Blend
9,601.1 03-31-08 -5.87 1
Vanguard Capital Opportunity VHCOX
Large Growth
8,901.9 06-30-08 -15.78 14
Columbia Marsico 21st Century NMTAX
Large Growth
8,108.8 07-31-08 -23.86 85
CGM Focus CGMFX
Large Blend
8,098.6 06-30-08 -17.77 37
Allianz NFJ Dividend Value NFJEX
Large Value
8,097.3 07-31-08 -14.84 14
Fidelity Capital Appreciation FDCAX
Large Growth
7,063.3 07-31-08 -21.75 69
* As of 09-25-2008.

Several of these funds have done quite well this year in relative terms, notably Fairholme FAIRX. That fund is actually overweight in financials relative to its category and the S&P 500, but the managers specifically avoided the likes of Lehman Brothers and AIG because of those firms' exposure to the complex derivatives that eventually took them down. Of the other funds on the list, several have little or no financial exposure in general, and CGM Focus CGMFX even has short positions in a number of financial stocks, though it has been pummeled recently by its huge energy and basic-materials stakes. Calamos Growth CVGRX and Columbia Marsico 21st Century NMTAX have done poorly this year because of their focus on traditional growth stocks, which have been hurt over fears about the economy.PAGEBREAK

It's not too surprising to see growth and blend funds avoiding prominent financial stocks, but it's more unusual for value funds, which tend to be heavy in financials. Only about 90 large-value funds have completely avoided our seven stocks, as opposed to nearly 500 large-blend and large-growth funds. The following table shows the 10 largest, which are much smaller as a group than the funds in the first table. (Because these are all large-value funds, there's no need to show each fund's category.)

 Biggest Large-Value Funds with No Exposure
 

Size
($Mil)

Portfolio
Date
Return
YTD
% Rank
Cat YTD
Allianz NFJ Dividend Value NFJEX
8,097.3
07-31-08 -14.84 14
BlackRock Large Cap Value MDLVX
4,092.4
07-31-08 -19.28 61
Principal Equity Income PQIAX
3,039.4
07-31-08 -17.12 33
Sound Shore SSHFX
2,505.6
06-30-08 -10.84 5
Eaton Vance Tax-Managed Dividend Inc EADIX
1,695.7
06-30-08 -19.08 59
Vanguard Dividend Growth VDIGX
1,695.4
06-30-08 -9.69 2
Schwab Dividend Equity Investor SWDIX
1,606.0
04-30-08 -15.19 16
Pioneer Equity Income PEQIX
1,143.0
07-31-08 -9.48 2
Columbia Dividend Income GSFTX
1,136.9
06-30-08 -15.73 20
Muhlenkamp MUHLX
968.9
06-30-08 -21.71 82
* As of 09-25-2008.

These funds have done better on the whole than the funds in the broader first group, in both absolute and relative terms. That's not too surprising, given that valuation-conscious funds of all stripes have generally done much better than speculative, growth-oriented funds in this market.

Most of these funds haven't gone out of their way to avoid financials in general; whereas six of 10 funds on our first list have financial weightings under 10%, that's only true of two funds on this list, and one of those, Muhlenkamp MUHLX, is the worst performer of the lot. Rather, most of these funds focus on dividend-paying stocks with low valuations, strong cash flows, and strong balance sheets, and that's what helped them avoid most of the financial meltdown. For example, Sound Shore SSHFX and Pioneer Equity Income PEQIX are among the category's best performers despite having almost 20% of their portfolios in financials, but the financials they do own are mainly insurers and retail banks with rock-solid balance sheets. Principal Equity Income PQIAX is overweight in financials relative to the category, but comanager Dave Simpson has specifically avoided the investment banks and other dicey financials like AIG and Wachovia WB, and the fund has benefited from smart stock picks such as Wal-Mart WMT and Union Pacific UNP.

A few of these funds, despite avoiding the highest-profile financial blowups, have suffered in other ways; Muhlenkamp, for example, has taken big hits from such prominent holdings as Terex TEX and UnitedHealth UNH. For the most part, avoiding the worst of the financial mess has helped these funds, but that avoidance is just one part of a discipline and value focus that has worked especially well in the current environment.

David Kathman is a fund analyst with Morningstar

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