Think Twice Before Throwing Low-Risk Stock-Fund Laggards Overboard

The current bull market hit its sixth birthday on March 9; stocks have more than tripled since early 2009.

To be blunt, extended bull markets can make us feel a little bit greedy. When everything is up by a comfortable margin over an extended period, investors often focus on finding the best relative performers, neglecting the fact that five-year annualized returns of either 12% or 15% are pretty darn good by historical standards.

A related phenomenon: The further away we get from the last bear market, the more we tend to understate the virtue of risk controls.

That's often a mistake. Funds that have disappointed during buoyant equity markets frequently make up ground during bear runs, often because they're more valuation- and quality-conscious than their peers. And because of that good downside protection, they do a good job of keeping investors in their seats; Morningstar Investor Returns data point to a correlation between low volatility and better investor returns.

Because equity valuations aren't exactly cheap today and investors should, realistically, expect more volatility ahead, today I'll highlight a group of low-risk funds that investors could be underestimating. To be sure, their near-term relative performance is underwhelming; all land in the lower echelons of their categories over the past five years. But all are Morningstar Medalists, earning ratings of Silver or better from Morningstar's analyst team, and all earn the designation of "core" holdings. Moreover, all have Morningstar Risk ratings of "low" and lost substantially less than the S&P 500 during 2008--the worst bear-market year since the Great Depression.

Category: Large Blend | Analyst Rating: Silver | Five-Year Return/Ranking: 12.02%/81 | 2008 Loss/Ranking: -23.48%/2

Want proof that highly leveraged, low-quality stocks have generally led the six-year market rally? Look no further than Amana Income's abysmal results during that period. The fund, which is managed for Muslims in accordance with Islamic law, avoids companies with debt/capitalization ratios of greater than 30%; as highly leveraged companies have enjoyed the biggest bounceback since the market and economy recovered, the fund's results have suffered. But the opposite phenomenon was in play during the bear market, as management's focus on dividend payers with solid balance sheets helped it to hold up much better than its peers and the broad market. Expenses are higher than is ideal, and management avoids financials stocks--a key market sector--because it can't invest in companies that earn or distribute interest; but senior analyst David Kathman considers the fund appropriate for Muslim and non-Muslim investors alike. The fund's

indicate that shareholders have been happy to stand pat despite the recent performance weakness.

Category: Large Value | Analyst Rating: Silver | Five-Year Return/Ranking: 11.51%/82 | 2008 Loss/Ranking: -20.05%/1

Downside protection is top of mind for this fund's management team, which was short-listed for Morningstar's Domestic-Stock Fund Manager of the Year honors in 2014. In addition to focusing the equity portfolio on high-quality dividend-paying companies with relatively low valuations--a risk-averse stock-picking approach--management further protects on the downside by holding a component of government-agency bonds, convertibles, and convertible preferred stocks. Owing to that low-risk makeup, the fund's standard deviation--a measure of volatility--is among the lowest of any large-value fund. While its five-year numbers are so-so, the fund has managed to deliver good investor outcomes:

tend to closely track the total returns of the fund, meaning that most investors have bought in and hung on. The fund may carry a sales charge if purchased through an advisor.

Category: Large Growth | Analyst Rating: Silver | Five-Year Return/Ranking: 13.13%/77 | 2008 Loss/Ranking: -28.97%/2

Although it lands in a completely different category, Jensen Quality Growth shares the American Century fund's focus on quality. Management's first cut is to screen for companies that have delivered returns on equity of 15% or better over the past 10 years. Then, they whittle that group down to those with the best growth and valuation profiles. The net result is a basket of companies with strong sustainable competitive advantages: The portfolio features a 71% stake in companies that earn Morningstar analysts' wide moat designation, whereas the large-growth category average is just 48%. Senior analyst Greg Carlson notes that weak picks in health care have dragged down returns over the past five years; management has since sliced its stake. But the fund's low-volatility results appear to encourage patience: Like the other two funds,

track closely with its total returns.