Finding Financials-Shy Large-Value Funds

The financials sector, particularly large U.S. banks, has been at the epicenter of the ugly economic environment and the deepening recession. The diversified funds most likely to invest in them, large-value offerings, have been hit hard as a result. Large-value funds have, on average, lost 51% of their value from the market's peak on Oct. 9, 2007, through March 13, 2009. But although the share prices of those banks that have thus far survived are down dramatically from their peaks, the prospects of further credit woes and possible nationalization make them high-risk propositions that could turn out to be value traps.

Some intrepid large-value funds making big bets on the sector now may end up profiting greatly if the share prices of banks rebound, but more risk-averse investors should probably seek out competing funds that are focusing their efforts elsewhere. To assist them, we're using Morningstar's Premium Fund Screener to identify large-value offerings that are going easy on the sector, have held up relatively well over the turbulent last 12 months, and have experienced skippers who have posted a solid longer-term record. So, we screened for funds that stash no more than 12% of their assets in financials (a third less than the large-value average) and have lost less than three fourths of their rivals over the past year. We also wanted funds that have outpaced 75% of the category over the past five years and have had the same manager at the helm for that entire span. Finally, we focused on funds that have a cost advantage over most competitors, so only funds with expense ratios of 1% or less made the cut.

 Click here to run the screen yourself. The Premium Screener generated the following results as of March 16, 2009:

 American Century Equity Income  (TWEIX)
 American Funds American Mutual  (AMRMX)
 American Funds Investment Company of America  (AIVSX)
ING Corporate Leaders Trust (LEXCX)
Ridgeworth Large Cap Value Equity (STVTX)
Valley Forge 

A light stake in financials is no guarantee that a fund won't take a hefty position in a financials firm that goes on to decline sharply, of course. But, in addition to the attributes we've sought out in our screen, most of the above funds are broadly diversified and weren't recently betting big on any individual financials stocks--only two of the funds took even a 2% position in any financials firm at the end of December 2008.

 American Century Equity Income (TWEIX) is one of those two funds. This offering focuses heavily on companies that pay out substantial dividends, but it tends to steer clear of deeply troubled fare (which may, because of a depressed stock price, sport high yields that could be unsustainable). Instead, the fund invests primarily in large companies with established franchises that it expects to crank out income for years to come. Phil Davidson has run the fund since its 1994 inception; although relative returns are often streaky, he's generated a superb long-term record here by sticking with steady-Eddie fare that tends to hold up quite well in tough times. The fund's biggest financial holding is insurance broker  Marsh & McLennan (MMC) (a 2.6% position), which is engineering a turnaround of its business from several years ago but hasn't run into major credit issues. The other fund that holds substantial positions in financial firms is the Ridgeworth fund, which holds a 3% position in money manager  Franklin Resources (BEN) and a 2.7% position in  J.P. Morgan Chase (JPM).

 American Funds American Mutual (AMRMX) might be the tamest fund on this list. Its four portfolio managers--each of whom runs a portion of the fund (a pool of analysts runs a sleeve as well)--likes cheap, established companies that pay dividends, but the fund also tends to hold a double-digit stake in cash to help preserve capital and keep dry powder for buying opportunities. This fund is easy to get comfortable with: Its managers boast an average of 33 years of investment experience, they're backed by a deep and experienced analyst staff, and the fund is one of the least volatile in its category. It tends to look sluggish when the market rallies hard, but long-term performance has been solid.

 American Funds Investment Company of America (AIVSX) boasts many of the same virtues as American Mutual: veteran skippers, substantial analyst support, a solid record, and broad diversification that has helped smooth the ride for shareholders. However, it's less of a pure value offering and doesn't put as much emphasis on dividends; its skippers will venture further into traditional growth stocks in sectors such as tech. As such, it tends to straddle the large-value and large-blend sections of the Morningstar Style Box. It's a fine offering, but investors might be better off with one of American Funds' pure value plays or a more adventurous fund such as  American Funds Fundamental Investors  (ANCFX).

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