Equity Funds That Mind the Downside
These funds have played good defense in the past, and may do so going forward, too.
About a year ago, I wrote an article suggesting that the biggest risk to investors was their own complacency. When the market performs well for a long period of time--as had been the case from early March 2009 through May 2015--investors tend to forget about past losses, and they also may get a little lax about risk controls. They allow their equity stakes to grow well past their targets, while investments with better defensive characteristics shrink as a percentage of the pie.
But if investors had lost sight of the importance of risk controls, even as reverberations from the Chinese market started earlier this summer, they're probably focusing on it now. After dropping 4% on Monday and another 1.4% on Tuesday, the S&P 500 is officially in "correction" territory, having shed more than 10% since its late-May high. Emerging-markets equities have performed even worse because those economies are more directly exposed to the fortunes of the Chinese economy.
It's rarely a good idea to make radical changes to your portfolio based on short-term market action; by the time you get around to swapping into the safe stuff, the damage has already been done. But the sell-off does provide a reminder to revisit your asset-allocation plan; for investors who have made no changes to their portfolios for several years running, lightening up on stocks in favor of cash and bonds is probably in order.
In addition, the sell-off underscores the virtues of intra-asset-class diversification. Even as higher-risk assets like lower-quality corporate bonds and high-priced growth stocks outperformed during the recent rally, quality has reigned during this market downturn (and many others before it).
To help identify equity funds that stand to be strong defensive performers if the market continues to be volatile, I turned to Morningstar's Premium Fund Screener. I screened for still-open funds that had performed well during the last major downturn, notching top-quartile results in 2008, that also earn Morningstar Risk ratings of below average or low. (Morningstar Risk measures a fund's volatility relative to its peers; funds with below-average losses in weak markets tend to earn good Morningstar Risk ratings.) And because past results aren't always predictive of what you can expect in the future, I also homed in on a few attributes that should hold funds in good stead if the market continues to be volatile. I screened for funds with average moat ratings of above average or better, because it stands to reason that higher-quality companies will hold up better in market downturns than lower-quality ones. (That was certainly the case in 2008, when Morningstar's Wide Moat Focus Index lost less than 20% even as the S&P 500 shed 37% of its value.) I further screened for funds that earn a Morningstar Analyst Rating of Bronze or better, meaning that our analysts believe they will outperform in the future.
The resulting list includes a number of Morningstar's longtime favorites, many of which have made other screens in the past, including one just this past week. Premium Members can click here to view the complete list; here's a closer look at three of the funds that made the cut.
American Century Equity Income (TWEIX) (
)Both this fund and sibling American Century Value (TWVLX) made our screen; the same quality-conscious, value-oriented team is in charge of both. While Value is typically fully invested in equities, Equity Income also usually holds a stake in convertible bonds and preferred stocks, which help boost its yield and have historically given it more of a cushion in down markets than its sibling. Both funds have long been fine defensive performers, however: In 2008, for example, both lost more than 10 percentage points less than the S&P 500.
Primecap Odyssey Stock (POSKX) (
)Senior analyst David Kathman considers this the most conservative of the various Primecap-managed funds; while its siblings land in various Morningstar growth categories, this one hits large blend. Kathman describes the seasoned managers' strategy as "patient contrarian growth," meaning that they look for companies with historically strong growth and the potential to continue it but that have become temporarily inexpensive for some reason. All of the Primecap-managed funds have enjoyed very hot performance over the past several years, raising the question of whether they're due for a performance slump. Nonetheless, the fund has held up well during the recent market turbulence.
Vanguard Equity-Income (VEIPX)
Owing to its low costs, sensible strategy, and experienced management team, I made this offering one of the core equity positions in my Vanguard Retirement-Saver portfolios. Michael Reckmeyer from Wellington Management runs about two thirds of the portfolio, while Vanguard's quantitative-equity group is in charge of the rest. The fund's low expense ratio helps ensure that its yield is one of the highest in the large-value category; unlike some similarly high-yielding peers, this fund doesn't have to venture into distressed companies to deliver its good payout.
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.