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Taking Stock of Mutual Funds Post-Downgrade

American bears are thriving while small-cap funds get bludgeoned.

It's been quite a roller-coaster ride in the past couple of weeks, so let's see if we can get our bearings. I'll take a look at some of the biggest changes in total returns and relative performance since the end of July. I'll also take a glance at some big themes.

It only takes a couple of days for things to change dramatically, and that's what we've seen. Assets that are perceived as having greater risk have been punished and those with less risk have been spared the worst of the market's wrath. Specifically, credit risk has been punished in the bond market as high-yield and investment-grade-corporate have been dinged while Treasuries have been bid up by investors who don't see the irony in lending more money to the United States Treasury over concerns about America's deficit. Precious metals have done well as a safe haven. Meantime, small caps have been hit harder than large caps. Overseas, Japan lost the least while Europe and Latin America were hit hardest.

Let's start with relative performance rankings and see which funds have seen their rankings change the most relative to their peers.

 Franklin Income (FKINX) has gone from top 5% to bottom 10% of its category as returns have gone from plus 5% to minus 2.5%. It's an instructive warning to anyone who owns an income fund that these funds can tackle the income challenge in a lot of ways. Franklin Income has a nominally conservative asset mix with much more in bonds than in stocks. However, it leans heavily toward yield on both fronts and thus is one of the more aggressive income funds around. Specifically, it owns a lot of high-yield bonds and that led to poor results in 2008 and again these past couple of weeks.

 Fidelity Overseas (FOSFX) slipped from a 4% gain to an 8.4% loss and its relative performance fell from 20 to 59. A big bet on Europe and economically sensitive stocks in particular has taken a bite. It's a shame because the fund had suffered three poor calendar years prior to this one and had seemed set to break that streak.

 Vanguard Asset Allocation  slipped from a 3.2% gain to a 5.7% loss, dropping its relative performance to 95 from 54. The reason is simple: The fund was aggressively positioned, with a heavy equity weighting and nothing in bonds. The fund allocates between the S&P 500, cash, and the Barclays Aggregate based on management's view of the prospects for each asset class. It can go from 0 to 100 in each class; most recently 73% of its assets were in stocks.

The Winners
John Hussman is a permabear, so the last couple of weeks were just the thing for his funds.  Hussman Strategic Total Return (HSTRX) actually made money, as returns rose to 3.8% from 2.3% and relative performance surged to 1 from 91. A wary Hussman had the fund almost entirely in cash and Treasuries.

 Akre Focus (AKREX) manager Chuck Akre was likewise wary about the U.S. economy but he expressed that wariness by buying some defensive names, including like  Dollar Tree (DLTR) and  TJX (TJX). A 15% cash stake didn't hurt, either. Thus, returns only slipped from 1.9% to negative 2.2% and the relative ranking soared to 13 from 79.

The story at  FAM Value (FAMVX) is somewhat similar to Akre's. Managers Thomas Putnam and John Fox look for low-debt companies with clean balance sheets, and those are the sorts of businesses that have held up better of late. They even have a big financials weighting, but it's in names like  White Mountain Insurance  (WTM) and  Berkshire Hathaway (BRK.B), which have held up fairly well. The fund has gone to 36 from 81 in the relative rankings and is down 6.7% on the year.

Staying with that theme, the closed  Artisan International Value (ARTKX), has also seen performance perk up. Managers David Samra and Dan O'Keefe are also balance-sheet mavens, and that discipline served them well in 2008 and again in the past couple of weeks. Relative performance has popped to 27 from 79. More importantly, the fund's trailing five-year return is in the top 2%.

Two more dependably defensive funds,  Tweedy Browne Global Value (TBGVX) and  Royce Special Equity  (RYSEX) moved up 50 percentile ranks spots over August.

Biggest Return Shifts
Now let's look at it from a total-returns perspective. Treasury funds saw the biggest gains, but let's look at the allocation funds and stock funds that fared best.

 PIMCO All Asset All Authority  is one of the very few allocation funds that actually remained in the black, with a 4.4% return only down slightly from a 6.4% return at the end of July. Manager Rob Arnott has been bearish on the United States for years due in large part to the federal deficit. This fund gives him wide discretion to invest wherever he sees the best opportunities. He had a 12% short-position bet against U.S. stocks, and was long some emerging markets and  PIMCO Unconstrained Bond's (PFIUX) portfolio.

 Merger Fund  (MERFX) just slipped into the red to negative 0.6% for the year to date. The fund does merger arbitrage, which requires going long the merger target and short the buyer. If they are right and the merger goes through, they collect a premium. If they are wrong, they will lose a chunk. Either way, though, the strategy isn't much affected by the market, so it typically holds up well in downturns.

 PIMCO Global Multi Asset  is still up about 1% on the year. The fund buys tail-risk insurance meant to protect against major losses in the markets. Near the recent lows we may have approached the point at which that insurance starts to pay off.

The Losers
Let's take a look at a few funds with the biggest declines so far in August

 Dreyfus Opportunistic Small Cap (DSCVX) fell to a 19% year-to-date loss from an 1% loss. I mentioned that small caps have been taking it on the chin and this is a perfect example. Manager David Daglio had a slew of tech, retail, and cyclical names that the markets spat out. He had a rough 2008, so this turbulence isn't out of character.

 Schneider Small Cap Value  lost nearly as much in August but was 11% in the hole at the end of July and is now down 27%. This fund also got clobbered in 2008. Arnie Schneider buys stressed-out companies in hard industries because simply returning to normal can produce big returns. The catch is that economic downturns can really hurt struggling companies. If fears are overblown this time around, the fund might have a nice rebound, but it's got a long way to go.

The carnage in small-cap momentum was also quite harsh. Witness the big declines suffered by  Bridgeway Small-Cap Growth ,  Bridgeway Micro-Cap Limited  , and  Turner Small Cap Growth . Each shed about 15% in August, but Bridgeway Micro-Cap was only about even when the month started, whereas the other two were at least starting from decent spots so that their year-to-date losses are under 10%.

What About FPA?
When I think of deficit bears, I think of FPA first and then Rob Arnott. Bob Rodriguez and others have been very vocal on the dangers of America's debt burden. So, I was naturally curious to see how their funds have done. The short answer is quite well. The superdefensively positioned  FPA New Income (FPNIX) edged higher as the fund stayed in the black with a 2% year-to-date gain.  FPA Capital  fell to a small 1.1% loss--that's better than 96% of its peers, so not too shabby. Steve Romick's  FPA Crescent (FPACX) also held up well with a 1.6% loss, which puts it in the top quartile of moderate-allocation funds.

How Did the Giants Do?
Looking at the 10 largest funds in the Morningstar 500 on a relative performance basis,  PIMCO Total Return (PTTRX) was the laggard and  American Funds Income Fund of America (AMECX), the star. Bill Gross' anti-Treasury move has dragged Total Return down to the bottom quintile of intermediate-bond funds while Income Fund of America is in the top 10% of its peer group, as its take on Income is more conservative than Franklin Income's. On a total return basis, PIMCO Total Return's 3.9% gain is tops among the 10 biggest funds while  Vanguard Emerging Markets Stock Index's (VEMAX) 12% loss is the worst.

 

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