The 10 Mutual Funds That Least Resemble the S&P 500

Diversification is a fine thing, but it's tricky. Do it right, and you can reduce overall risk while nudging up returns. But do it wrong, and you're just throwing money away on a goofy investment.

Conventional wisdom holds that if you're starting to build a portfolio, you should begin with large-cap funds and then add some small caps and bonds, whose performance will be less like those large-cap giants. After that, adding diversification gets trickier because you get into more obscure areas, some of which can quite volatile on their own. Some planners suggest some commodity plays, such as a natural-resources fund or a precious-metals fund. Such vehicles behave quite differently from the S&P 500, and that can be a good thing.

But another way to add diversification is to buy a more traditional equity fund that doesn't act like the stock market. There aren't many, but there are a handful of U.S. stock funds from our nine Morningstar Style Box categories (small value, large blend, etc.) that have a low R-squared relative to the S&P 500. R-squared measures how much a fund's moves are explained by an index. An S&P 500 index fund will have an R-squared of 100, while a money market fund will have an R-squared of zero. Note: You can find a fund's R-squared figure in the Risk Measures section of a fund's Quicktake.

Most U.S. stock funds have an R-squared versus the S&P 500 of 75 or higher, but there are a few with much lower correlation. To behave really differently than the broad market, a fund has to be concentrated by stock, industry, or both. So, a fund that just holds tech stocks and homebuilders will have some overlap with the broad market, but when natural resources or financials make a big move, it won't have much of an impact on the fund. Because of their focus on individual stocks or sectors, most of these low R-squared funds should be kept to position sizes of less than 10% of assets.

I screened for domestic-stock funds with R-squareds below 40 and, to keep out the crazies, I excluded funds with less than $10 million in assets and expenses higher than 2.00%. The 10 funds with the lowest R-squared are an interesting mix, though not all are keepers.

Pinnacle Value (PVFIX) R-squared: 17
The story is much more straightforward here. Take a look at the Ownership Zone on the Snapshot page, and you'll see the fund is way down in the left-hand corner of the style box. The fund owns mostly micro-caps and uses a deep-value strategy. That's sure to make a fund different than the S&P 500.

CGM Focus R-squared: 20
Like the name says, the story here is focus. Ken Heebner is an opportunistic investor who goes wherever he finds cheap stocks, and then he invests with conviction. Some of his biggest bets are steel, telecom, investment bankers, and oil services. But don't look for him to stay there forever. The fund has 333% turnover. In addition, he'll short stocks on occasion--a practice sure to make the fund unmarketlike.

Gabelli ABC (GABCX)R-squared: 24
And now for something completely different. CGM takes a wild ride to be different, but Gabelli ABC is different on the quiet side. Manager Mario Gabelli buys merger targets before the deal is complete in expectation of making a few bucks between the target's market price and the price of the actual deal. Of course, a bidding war for the target can really make the fund some money. Either way, merger target stocks tend to move entirely based on the prospects of the deal going through or changes in bidding. What's happening in the market has little impact on the stocks--hence the low R-squared. In addition, Gabelli has let cash build on occasion when there aren't enough good candidates. This is one of the least volatile stock funds around.

 Sequoia (SEQUX)R-squared: 25
This closed legend is sort of a cross between the CGM and Gabelli funds. It's concentrated like CGM but has much lower turnover and is much less risky. Lead manager Bob Goldfarb has 29% of the fund in Berkshire Hathaway (BRK.A) and invests the rest in a decidedly Buffettlike way. He looks for great companies with long-term competitive advantages whose shares are trading at a fair price. Then he holds on for a very long time.

Becker Value Equity  (BVEFX)R-squared: 29
A big bias toward industrials and consumer goods makes this fund act differently from the S&P 500.

Philadelphia R-squared: 30
Talk about quirky--this fund has just 28 stocks and nearly all of them are either utilities, energy, or financials.

Copley (COPLX)R-squared: 30
We're getting quirkier. Manager Irving Levine, working on his 30th year at the helm, has 51% of the fund in utilities and 22% in energy.

 JHancock Large Cap Equity (TAGRX)R-squared: 31
This fund may be the biggest surprise on the list: It is a large-cap-dedicated fund that sounds like it's meant to be a core holding. But check out the sector bets: 32% in industrial materials and 31% in energy. On top of that, 35% of the fund is overseas. Those are some huge bets, but so far they've worked out quite well for lead manager Tim Keefe, who has been at the helm since 2004 and had a prior stint from 1996 to 2000.

 Fairholme (FAIRX)R-squared: 34
This fund is one of your favorites and one of our analysts' favorites, too. It's easy to see why. You can't get into Sequoia, but you can get into Bruce Berkowitz's outstanding Buffett-inspired vehicle. He's focused, he's low turnover, and he's rarely off the mark. The reason the fund doesn't track the S&P 500 is that the fund has a mere 21 holdings with 17% in Berkshire alone.

Correction on Equitrust Value Growth
Earlier versions of this column mentioned Equitrust Value Growth   as having a low R-squared. However, that was based on incorrect return data. The fund does in fact have a higher R-squared than stated. We regret the error.