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By Christine Benz and Russel Kinnel | 12-01-2014 04:00 PM

3 Funds That Mind the Downside

Five years into the current bull market, investors might want to consider funds that emphasize risk control, says Morningstar's Russ Kinnel.

Christine Benz: Hi, I'm Christine Benz for We're more than five years into the current bull market, so it's probably a good time to look at how funds would behave on the downside. Joining me to discuss that topic and to share some low-risk picks is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, you recently wrote a cover story for Morningstar FundInvestor in which you looked at a statistic called downside capture. Before we get into that, I'd like to get your take on why it's a good time to be thinking about the volatility that might come along with certain mutual funds that you might be considering?

Kinnel: Well, as you said, we've had a great five-year run in U.S. equity markets. Usually, bull markets don't last that much longer. So, the longer you have a rally, the greater the chances that you'll then have a correction--not that I have a crystal ball telling me it's next week or even two years from now. But I think the further you get along in a bull market, the more it makes sense just to think about caution and also to look at performance through that lens because, of course, the most aggressive funds tend to best in rallies. So, it's good to keep in mind as you look at the performance of the last five years that it's really been slanted in the favor of those more aggressive funds.

Benz: So, some lower-risk funds really may not look that great when you look at their five-year returns, if you're looking at returns only. But you say to dig in and look at some statistics regarding risk. The specific one that you point to is downside capture ratio. Let's discuss what that is and how we calculate it.

Kinnel: So, downside capture ratio is referring to capturing the downside of a broad market index--the S&P 500, MSCI EAFE, Barclays U.S. Aggregate Bond Index. So, it specifically just homes in on when the market has gone down. For instance, if the S&P has gone down 10% and a fund loses 15% over that period, you'd have a downside capture of 150%. So, what percentage of the downside did that fund capture? Less than 100% is a good thing; more than 100% means it's doing worse than the market in down periods.

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