Keep an Eye on the Downside

It's been quite a while since the last bear market. So this is a fine time to check in on fund downside--specifically, the downside capture ratio.

This measure tells you how much of an index's losses are captured by a fund. Say the S&P 500 loses 10%. A fund that lost 12.5% over the same period would have downside capture of 125%. One that lost 7.5% has downside capture of 75%.

That differs from Morningstar Risk in two key ways. First, the Morningstar Risk rating is relative to a fund's Morningstar Category, whereas downside capture is relative to a broad index such as the S&P 500, MSCI EAFE, or Barclays U.S. Aggregate Bond indexes. The further a fund's portfolio diverges from from those indexes, the less helpful the downside capture measure is.

Second, Morningstar Risk looks at volatility in both directions, though it penalizes losses more, whereas downside capture tells you only about the red ink. The reason Morningstar Risk takes a more holistic view is that volatility on the upside can often later mean volatility on the downside.

For this article, I sought funds with low 10-year downside capture ratios in order to find some lower-risk funds. Five-year measures wouldn't include the 2008 bear market. I also selected funds in categories where those broad benchmarks are good fits: U.S. large-cap equities, foreign large-cap equities, and intermediate bonds. To ensure I was on the right path, I screened out funds that had high Morningstar Risk and funds that were not Morningstar Medalists. I included funds closed to new investors because those who own the funds still need to decide whether to keep them.

Foreign Large Caps

U.S. Large Caps

Silver-rated

Intermediate Bond Risk in the bond market is certainly a concern. Rising rates would punish funds with long-duration portfolios, and a recession or other credit debacle would burn funds with low-quality portfolios. The three downside champs listed here are far from risk-free, but they've at least navigated those risks well in the past.