Reversal of Fortune: Cautious Medalists Shine

Market volatility can prompt big shifts in funds' Morningstar Category rankings, especially over the short term. While that may not matter much for investors who pick good funds and sit tight for the long haul, it can cause others to panic and make hasty decisions. One key to keeping calm is understanding your funds' risk profiles. Funds that court risk relative to peers tend to do poorly in volatile markets, while the steady-Eddies tend to hold up better.

Christine Benz's recent column "A Third-Quarter Mutual Fund Scorecard" reviewed how Morningstar Medalists fared in the late summer's wobbly markets. Here, we take a closer look at four U.S. equity fund medalists--two category ascenders and two descenders. In retrospect, each fund performed in line with expectations.

The Leaders

Entering 2015's third quarter,

The fund's strategy provided some shelter in 2015's third quarter. Sizable positions in Wells Fargo convertible preferreds and consumer staples stocks

To be sure, the fund still lost 3.3% in the third quarter, but that return beat the Nasdaq U.S. Dividend Achievers Select Index's 5.6% loss and the 6.8% drop by the broader Russell 1000 Index. Versus large-blend peers, the fund's showing during the past three months propelled its year-to-date category ranking from the bottom to the top quintile.

Since manager Donald Kilbride took over the fund in February 2006, few category rivals have produced a better record, especially when adjusted for risk. The fund's 8.2% annualized gain from Kilbride's start date through September 2015 easily places in the large-blend category's top decile, while its standard deviation is one of the lowest among about 320 category peers with a track record that long.

The Laggards The next two funds began July as top-quintile year-to-date performers within the mid-blend category, only to plummet to the bottom decile by the end of September. Although both are good funds, given their more-aggressive profiles, short-term underperformance should not come as a surprise.

Closed to new investors since July 1997,

The managers' stringent value discipline can lead them to build stakes in troubled parts of the market, which explains the fund's overweightings in the downtrodden energy and materials sectors. That walloped the fund in the third quarter; its 16.1% loss trailed the Russell 2000 Index by 4.2 percentage points. Primary culprits included

A contrarian, concentrated strategy can make for a bumpy ride, but over the long haul the fund has consistently beaten the index and most category peers. In 190 rolling 10-year periods from the late 1989 start date of longest-tenured manager Mason Hawkins through September 2015, the fund's returns are superior to the index and category norm 94% and 92% of the time, respectively. The fund has a Gold rating.

At the beginning of the third quarter, the fund's portfolio was geared toward indebted companies in economically sensitive sectors--factors that typically don't perform well in market jitters. The average debt/capital ratio of the fund's holdings was 43.3%, ranking it in the mid-blend category's top quartile and higher than the Russell 3000 Value Index's 37.9%. The fund was overweight materials and semiconductor stocks and had roughly 19% of its assets in foreign names. All of these attributes contributed to the fund's 18.5% loss for the quarter, nearly 10 percentage points worse than the index.

The fund has a history of sinking fast in turbulent conditions. In 2011's third quarter alone, it lost 24.3% on its way to a bottom-decile finish that year. In rallies, though, this fund can soar. It posted top-decile calendar-year showings from 2009 to 2010 and again from 2012 to 2013. Investors who lack a stomach for volatility should stay away. Those willing to tolerate dramatic performance swings can benefit, however. Since longest-tenured manager Higgins joined the fund in June 2008, its 8.4% annualized gain through September 2015 beats the index by 1.9 percentage points and lands in the category's top quintile.

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