Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The U.S. market is off to its worst early-year showing in history. Joining me to discuss a group of funds that have held up fairly well amid the rout is Russ Kinnel--he's director of manager research for Morningstar.
Russ, thank you for being here.
Russ Kinnel: Good to be here.
Benz: We're more than midway through January; it's been a very tough year for investors, really, across the board--unless they happen to be in Treasuries with their portfolios. Let's talk about a select list of funds that you took a look at that have actually held up pretty well amid this period of broad market weakness. A couple of the funds that have performed really well are foreign-stock funds. These are funds that you say you're not surprised to see holding up quite well amid this tough environment. Let's start with IVA International (IVIOX). That's the first fund on your list.
Kinnel: That's right. And I would add, as a note of caution, too: All of the funds we're going to talk about today are funds that have lost money. Just about any equity-owning fund is in the red; but if you can lose 5% or 10% less than your benchmark and peers in a down market, that's a great way to beat the index, especially on a risk-adjusted basis. And of course, it's a very welcome thing to do. IVA International is a fund that is very defensive, so we expect it to do well. Though, it's still encouraging that it's done well. It holds some gold, it holds a lot of cash, and it's also invested in defensive stocks--meaning companies that tend to hold up well. So, it's a fund very much focused on capital preservation, and we're seeing it do that so far this year.Read Full Transcript
Benz: So, when you have these big rallies in equities, it's not a fund that typically looks especially strong. It earns its keep in down markets like the current one.
Kinnel: That's right. Its value proposition is that they're going to hopefully keep close to peers and benchmark in rallies but lose much less [in down markets], which is obviously a really important thing that investors place a tremendous amount of value on.
Benz: I always think of the next fund on your list as a relative of the IVA fund because there have been some interrelationships among its management. It's First Eagle Overseas (SGOVX). Let's talk about that one. You say it has a similar complexion.
Kinnel: That's right. They both started with similar philosophies, even similar people at both firms. And so, again, you have a focus on capital preservation, you have sizable cash stakes, and you have some gold for defensive purposes. That's gold bullion, usually, at both of these funds, and gold--like Treasuries--is among the rare things that have actually done well so far this year. So, again, this is a fund that's losing significantly less than its peers, and that's an encouraging sign.
Benz: Those are both foreign-stock finds. Let's talk about, on the U.S. equity side, one of the funds that has held up really well in this period of broad market weakness. It's a Gold-rated fund: Vanguard Dividend Growth (VDIGX). It's a fund that we've long liked. Let's talk about why it has been playing such strong defense.
Kinnel: We often talk about that as one of our favorite funds here. This year, it's showing why, because their emphasis is dividend growth. And to be a company that grows its dividend, you have to have a pretty good balance sheet, some growth prospects, as well as the ability to pay a dividend. That kind of ends up being a de facto quality screen, so Vanguard Dividend Growth is a fund that has, so far, held up well in this down market. It held up very nicely in '08--meaning losing less than its peers. You have names like Coca-Cola (KO) and McDonald's (MCD) that often do well in downturns because of the defensive nature and because their brands mean their profits and revenues hold up pretty nicely in a down market.
Benz: This is a fund that has gained a lot of interest. We've seen assets flow into it. Have you and the team looked at the issue of whether asset size could hobble it in the future?
Kinnel: It's definitely a concern anytime you have as much growth as you see a fund like this. If you think about the stocks I mentioned--Coca-Cola and McDonald's--this is a very large-cap process; there's an emphasis on pretty big names that have a lot of liquidity. So, the impact of asset growth is going to be much smaller, and I think the downside, therefore, is much smaller, too. You might eventually lose out on the ability to invest in a few of the companies at the smaller end of large caps, but it's not going to be too dramatic. So, we think this is less of an issue. I think where it might become an issue is if, say, they had to add a second subadvisor. Don Kilbride and Wellington have done such a great job--we'd hate to see that. But so far, we still feel pretty good about the fund.
Benz: Another fund on the list is a growth-leaning fund. I think it's one that maybe some investors had lost a little bit of confidence in, but we're seeing it do what we might expect it to do, year to date. This is ASTON/Montag & Caldwell Growth (MCGFX).
Kinnel: That's right. It's a fund that's in the large-growth category, and that means it's in there with a lot of aggressive funds; but it's not that aggressive itself. It's much more an emphasis on high-quality names, so it doesn't have a lot of the fastest-growing tech and healthcare--which means, prior to this year, it was lagging. But historically, it's done pretty well. It's another good defensive-growth name because of that emphasis on high quality. It's held up in previous downturns as well. So, it's a nice steady play, and it straddles the line between blend and growth.
Benz: One thing we've seen in this current period of market weakness is that, generally, small and mid-caps have underperformed large, and also growth-leaning funds have generally underperformed more value-leaning ones. Let's talk about a small-cap fund that you pointed out as having pretty distinguished performance, year to date. That's Royce Special Equity (RYSEX).
Kinnel: It says something when you talk about really good performance being a 7% or so loss. That's actually one of the best in its category, and that's because it has been a hard-hit area. We're seeing smaller energy names and some other economically sensitive names get hit really hard; but again, this is a fund that has consistently done very well. I don't really put it in the quality bin with some of the other funds we're talking about. But what Charlie Dreifus does is he looks for companies with very good accounting, very good balance sheets. That keeps him out of energy and keeps him out of some of the other economically vulnerable names. So, even though the fund had a rough performance last year, it's a relief to see that it's holding up much better than its peers this year, and some of those qualities of defensive kinds of companies are still working out for the fund.
Benz: Small value: People are talking about whether we're sort of in the late stage of this long rally. Is small value a category that typically performs well in such an environment?
Kinnel: Small value is usually one that is vulnerable to an economic recession because you have a lot of economically sensitive companies. It's much more sensitive to the U.S. economy than the global economy, which recently has been a plus. But as we've seen some negative signs for the U.S. economy, maybe that's a negative. But yes, we had a very long rally for small value, so it's not really surprising that this year--and in 2015 as well--they're giving some of that back because they had a really nice run.
Benz: Let's talk about the last fund on your list. It's a mid-cap growth fund called Akre Focus (AKREX). Why do you think it's been holding up so well in 2016, so far?
Kinnel: Well, Chuck Akre really emphasizes companies with strong cash flow, defensible positions, and steady growth. So, again, this is a fund that isn't like the growth funds chasing the hottest biotech or tech names; it's much more into steady names. It's got stuff like Dollar Tree (DLTR), Markel (MKL), and NSTAR (NSARP)--kind of to the boring side of growth. But you see the beauty of that dullness in a year like this. Akre has just done a really good job with a focused portfolio--one of the best growth investors out there.
Benz: Russ, just to conclude, you've presented a good list of funds that have held up well; I know a lot of times investors go through periods of market weakness like this, and they tend to want to gravitate to funds that do have these defensive characteristics. Are there risks to maybe glomming onto them or chasing performance that may not be repeatable?
Kinnel: Yes, I think so. I think that's why you want a mix of these kinds of defensive funds with other kinds of funds as well, because markets go in cycles. And whenever you are building your portfolio, you have to recognize that things may look good at this particular end date, but there is usually some kind of bias--either more aggressive or less aggressive funds look good. So, you want to appreciate that. A number of the funds we touched on have this kind of quality bias, which is great, but it means you don't have some of the other kinds of stocks in there. So, I think it's great to have some of these names because more-defensive names mean your portfolio is going to lose less in a downturn. That's vital to most investors, particularly in keeping them invested. But you don't want your portfolio to be all defense. Unfortunately, some people made that mistake in 2008-09; they went with defensive or even bearish names, and then they missed out on a lot of the rally. So, I think a good, healthy mix of names that are going to work well in different environments is ideal.
Benz: Russ, it's been a tough market so far in 2016. Thank you so much for being here to share your insights.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
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