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Four Mutual Fund Bear-Market Horror Stories

What went wrong at these hard-hit funds?

Russel Kinnel, 07/15/2008

Ouch. We are flirting with bear market territory as the twin shocks of skyrocketing oil and a credit crunch ripple through the economy and the markets. As is usually the case in market corrections, it isn't a matter of everyone taking two steps back. You have pockets of pain and pockets of serenity. Most bond funds are only down a hair for the year to date, yet you can find some that have been absolutely cold-cocked.

A while back I made the point that many investors had made the very flawed assumption that value funds hold up better in bear markets. That's not really the case. It just happened to work that way last time. In market history, though, value is just as likely to get tagged as growth, though it does at least have less price risk. That's particularly true when it coincides with a recession, which hurts economically sensitive stocks favored by value managers. Another way of looking at it is that most bear markets are caused by crises in an industry or two and each industry gets its turn to get clobbered, therefore each investing style will have its bad moments.

The last bear market pummeled massively over-hyped tech and Internet names, and this one is hitting financials hardest and anything vulnerable to rising oil prices second.

Let's take a look at four particularly hard-hit funds and their year-to-date losses to understand where the most pain is as well as what they say about risk. (I'm going to save hard-hit Legg Mason Value LMVTX for later in the month, and we've covered the issues at Schwab YieldPlus SWYPX and Regions Morgan Keegan in depth already.)

Eaton Vance Greater India ETGIX--negative 44.6%
In the Morningstar FundInvestor annual guide on where not to invest, I said to be wary of Asia funds, particularly China and India funds. I don't have any timing skill or special insight that this was the moment when China and India would take a tumble. It's just that speculation was out of control and that makes markets vulnerable to a correction. As it happens, it's the price of oil that turned those markets from euphoria to despair awfully quickly. Some U.S. and European manufacturers are shifting production closer to home because fuel costs are negating the wage advantage of China and India and that's depressing the markets. India now estimates that manufacturing production will slow to its lowest growth rate (2.9%) since 2001, and there are worries that oil prices will cause a spike in inflation which, in turn, could spur interest rates higher and hurt growth.

We've seen similar sell-offs in Mexico and Asian Tigers before, and one can make a case that China and India will rebound eventually. That still leaves the problem that many India and China funds have absurdly high expense ratios, but at least the markets are getting to more-reasonable valuations now.

Kinetics Market Opportunities KMKNX--negative 30.7%
First we saw the downside of an aggressive regional fund and now we're seeing the downside of an aggressive sector fund. This fund smoked the competition last year with a 34% gain because of its very narrow focus on trading exchanges and asset managers. Now, you can see that focus comes with a price. Big holdings in NASDAQ, CME, NYSE, and Legg Mason have pummeled the fund. When I look at a sector fund, I want a true expert in the field, and I'm not sure that Kinetics has an edge in picking financials over the likes of Davis.PAGEBREAK

Oppenheimer Rochester National Muni ORNAX--negative 12.6%
Be wary when a bond fund doesn't just outperform--it crushes the competition. This fund's big weighting in tobacco bonds helped it to whomp everyone for more than 10 years. When I wrote that I preferred Fidelity and Vanguard to Oppenheimer because Oppenheimer took some big risks, I got a number of angry e-mails. They said that it obviously wasn't risky because it had been working for more than a decade. In bond funds, most investors don't want to take big risks--they want steady returns and income. The good news is that tobacco bonds could rally. The bad news is that the fund is now down more than 20% for the trailing year and it just lost a star--it is down to 2 stars. If that should begin to translate into outflows, there could be more pressure on the portfolio.

Touchstone Large Cap Value TLCAX--negative 29.43%
If you are squeamish, don't click through to the graph on this one. The fund is off a horrific 52% for the trailing 12 months. The story here is financials but not the same ones that are hurting the Kinetics fund. Manager John Schneider tried to do some bottom-fishing, but the fund's huge exposure to mortgages has backfired. Top holdings Fannie Mae FNM and Freddie Mac FRE are down 50% for the year, and the fund also owns Wachovia WB and Washington Mutual WM. Even its forays outside financials have been brutal with names like Ford Motor F, Centex CTX, and Motorola MOT. This shows how things can turn against a value portfolio that seems diversified and is full of recognizable names. Just about any focused fund like this one runs the risk of taking a big hit, so you have to truly be long-term to get in.

Russell Kinnel is director of mutual fund research with Morningstar.

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