Large-Cap Funds for Those Who Fear the Bear

These are strange days for equity investors. On one hand, stocks have been on a remarkable extended run that seems to defy gravity--and expectations. On the other hand, the fact that we've been riding this bull since back in early 2009, making it one of the longest sustained rallies on record, has some investors preparing for at least a correction (defined as a 10% drop from the market's recent high) if not an outright bear market (defined as a 20% drop from the high). Yet these fears are not exactly new.          

Market prognosticators have been on a bear watch for years now. Some expected a market pullback in 2013--and boy, were they wrong. Instead, the S&P 500 gained 32% (including dividends), its best year since the late 1990s. Naturally this strong performance stoked additional predictions of a bear market in 2014, but so far the big, furry beast has been nowhere in sight. Despite a rocky start to the year, the S&P 500 returned 7.1% for the first six months of 2014 (for more on the market's recent performance, read "Our Take on the Second Quarter").

At present the market does look slightly frothy, trading at 104% of fair value based on Morningstar equity analysts' estimates of the stocks they cover (you can read more about their outlook for various market sectors here). But no matter which way the market is headed in the near term, sooner or later a pullback--if not a downright bear market--will come.

For investors seeking clues as to how vulnerable a fund is during a market decline, one useful tool is the Bear Market Percentage Rank metric, found on Morningstar.com fund pages under the Ratings & Risk tab. The Bear Market Percentage Rank for equity funds is calculated by looking at how the fund performed relative to all equity funds during months in which the S&P 500 lost more than 3% (or, for bond funds, how it performed relative to all bond funds during months in which the Barclays Aggregate Bond Index lost more than 1%) during the previous five years. Of course, given that the current bull run is more than five years old, there haven't been as many months that qualify as downers as there were in previous time periods. (In fact, there have been only nine such months during that time frame, the most recent of which being January of this year, when the market lost 3.6% coming off last year's strong showing.) Even so, a glance at your fund's Bear Market Percentage Rank, in conjunction with other metrics such as long-term standard deviation, should give you some indication as to how it will perform in a prolonged down market.

With the help of the  Premium Fund Screener tool we searched for large-cap funds with Bear Market Percentage Ranks that place them in the top fourth of performers--in other words, funds that have performed much better than the average equity fund during months when the market has lost value during the past five years. We've excluded institutional funds and those closed to new investors, though users who would like to see them can simply remove those screening options. Premium Members can see the full list  here. Below are some analyst-recommended funds that make the cut.

One common theme: lackluster recent performance. Funds that fare better in bear markets tend to play it safer than their peers, meaning they are prone to lag in strong bull markets.

 First Eagle US Value (FEVAX) (
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Although relative results have been sluggish lately, this large-blend fund has offered resilience when markets sour, says Morningstar senior fund analyst Karin Anderson. The management team's first priority is capital preservation, and they invest primarily in equities based on their own assessment of a company's intrinsic value while also focusing on margin of safety. They'll own high-yield corporate bonds, as well, and typically keep plenty of dry powder, as shown by the fund's current 20% allocation to cash, allowing them to jump on opportunities as they arise. This large cash stake has weighed on recent performance, causing the fund to lag its peers, though its Low Morningstar Risk rating speaks to reduced volatility. The fund may charge a sales load.

 Vanguard Equity-Income (VEIPX)
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This large-value fund maintains a more conservative portfolio than many peers and remains well-positioned should equity markets back up, says Morningstar senior fund analyst Kevin McDevitt. The fund invests primarily in high-quality U.S. companies with above-average yields. Assets are split between two advisors--Wellington's Michael Reckmeyer, who manages a little more than 60% of assets, and Vanguard's equity investment group. The fund's 10.6% showing in 2011, when markets were essentially flat, was among the category's best that year. Low expenses (0.30%) have helped the fund deliver one of the category's better long-term records--it's been a top decile performer for the trailing three-, five-, and 10-year periods--without taking on extra risk. Plus, the fund's 2.5% trailing 12-month yield is among the highest in its category.

 Weitz Value (WVALX)
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This fund has kept its returns competitive despite lugging considerable dead weight--namely, a 30% allocation to cash (as of March 31). The fund isn't managed for year-to-year consistency, and its managers are happy to ride out the lumpy returns common to concentrated, contrarian strategies. The fund has become more diversified across sectors since getting burned by financials during the credit crisis--it lost 40.8% in 2008, about 3 points worse than the large-blend category average. Its strong recent relative performance may wane if the equity surge continues, McDevitt says. But when the eventual correction comes, the team will be in position to do what it does best: buy right.

Ratings as of July 8

Editor's note: This article has been changed to reflect the fact that the Bear Market Percentage Rank metric is calculated based on a fund's performance relative to all equity funds, not just those in the same fund category.