Fund Winners and Losers During Recent Volatility

Karen Wallace: Volatility returned to the market in a big way last week, taking many investors by surprise after the recent tranquility. Here to discuss which fund categories held up the best, and performed the worst, is Russ Kinnel. He's director of manager research, and he's also editor of Morningstar FundInvestor.

Russ, thanks for being here.

Russ Kinnel: Good to be here.

Wallace: Let's start off by talking about some of the suspected causes of the volatility. What was going on in the market last week?

Kinnel: I think we're still trying to figure out what was going on. We know that worries of inflation were growing, and interest rates were rising in response to that. The rest of it is anyone's guess, it's really hard to tell at this point.

Wallace: Which fund categories were the hardest hit last week?

Kinnel: Interest-rate-sensitive ones were among the hardest hit--long-term bonds, real estate and utilities, both of which are yield-driven, were really hard hit.

Wallace: On the flip side, which categories did pretty well last week?

Kinnel: Large growth did well, at a relative basis, as it lost less than small value. Bank loan funds do well because they reset their interest rates as interest rates rise, so they're better protected. Foreign equity funds did better because they're exposed to foreign currencies, and when the dollar falls they will lose less in a market like this.

Wallace: If we're going to put this in sort of a larger context, how should investors think about a one week performance of a fund?

Kinnel: I think it tells you something about where their exposures are. Obviously you can't read anything about manager skill. It's just kind of a blip, but it still gives you some sense of where their bets were, if nothing else.

Wallace: For example, we downgraded a fund from Neutral to Negative, the LJM Capital and Preservation Fund, because it became clear that they did not have proper risk controls for their options-writing strategy. Can you talk about that a little bit?

Kinnel: This is a really unusual case, this is a fund that lost 80% of its value in one week. What they're doing was shorting volatility, and that really blew up on them, obviously they were taking a tremendous amount of risk. And then on top of that it appears that they had margin calls, had to sell at very fire sale kind of prices, and took another hit on top of that. It's really been a mess. They're also posting their net asset values late; we still haven't seen a new one since Feb. 7, so we've missed a couple days of net asset values. It's really unclear exactly what's going on, but it's kind of shocking for really just a modest downturn, and a modest spike in volatility.

Wallace: Russ, thanks so much for the update, and thanks for being here.

Kinnel: You're welcome.

Wallace: For Morningstar I'm Karen Wallace, thanks for watching.