Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.
A few fortunate equity-fund investors have nerves of steel. They barely notice the typical dips in stock prices. Even when the market falls off a cliff, they’re unruffled, calmly analyzing the causes and then searching for treasure amid the rubble like patient, dispassionate archaeologists.
Most of us are not like that. When markets tumble and our investment accounts suddenly shrink, our anxiety level understandably rises. We think about selling, not buying. Even standing pat takes guts. That natural reaction explains why funds that can withstand market shocks better than the indexes and their peers have value. Although only rarely do they totally avoid the downturns, by reducing the magnitude of the declines they can prevent shareholders from turning a scary but ultimately harmless paper loss into a damaging real-life one.
For this reason I felt it appropriate, in the wake of a historic market plunge, to check on the performance of equity funds that typically provide--or that Morningstar Manager Research analysts think should provide--a measure of protection in tough times. To choose the funds, Morningstar analysts and I identified a list of funds for which we assign Morningstar Analyst Ratings and that we expected would hold up better than most peers and the relevant index in a steep downturn. We based these expectations on the funds' portfolio metrics, cash levels, and past performance during stock-market sell-offs, along with other traits.
To be clear, in most cases we had written about these traits and the performance one should expect of these funds in a downturn in our coverage of the funds long before the novel coronavirus struck. As you'll see, we didn't simply look at results after the fact and choose the most noteworthy outperformers. I did not include offerings explicitly labeled as defensive or low-volatility. (For those curious, my colleague Dan Sotiroff says low-volatility funds generally held up well.)
Please don’t be misled by the past tense: I’m not declaring the market crisis to be over. Early April’s market rebound could easily reverse course and stocks could hit new lows. But as of now, given the magnitude of the rebound, it makes sense for this purpose to focus on the period from the market’s first-quarter high point to its low point (and, for simplicity, to refer to that as the bear market period, even if the indexes didn’t technically exit the widely accepted bear market threshold the day after the low point).
The Good (Well, Somewhat Encouraging) News Most of the funds suggested by our team did surpass their Morningstar Category benchmarks and category averages. This welcome news is tempered by the fact that these offerings still suffered huge losses, and we recognize that shareholders aren't necessarily thrilled to see their fund drop by 25% or 30% even if it outperformed rivals and benchmarks. That said, outperforming even modestly in downturns does pay off in long-term results. And it can have another beneficial effect. If shareholders can see not only a sizable loss but also that, in a very tough time, their fund beat most of its rivals and the relevant benchmark, that may encourage them to stick with the fund instead of taking the drastic and ultimately harmful step of selling at or near the market's low point.
Amana Income Institutional AMINX The longtime lead manager of this $1.2 billion fund will retire in May, but the approach that has made it one of the least volatile large-blend funds remains in place. Although it did suffer an unpleasant 30.8% loss during the bear-market period, that was 3 percentage points milder than the large-blend category average and 4 points ahead of the Russell 1000 Index. It has several characteristics that helped. Its adherence to Islamic law means it can't own financial stocks--most big bank stocks were hammered--and it likes dividend payers with strong balance sheets, a good fit when investors were skittish about companies' financial strength.
American Century Equity Income TWEIX This fund also likes dividend payers and favors companies with low debt loads; moreover, it consistently devotes a meaningful chunk of assets to preferred stocks and various types of bonds, both of which are less volatile than common stocks. The fund's Institutional shares declined 32.5%, as value stocks took by far the biggest hits during the crisis period, but that was nearly 6 percentage points better than the Russell 1000 Value Index's loss and 5 points ahead of the large-value category average. Under the longtime leadership of Phil Davidson, this fund has outperformed both measures over the 10- and 15-year periods as well.
American Funds New World NFFFX Capital Group waited until the end of the 1990s, after some notable emerging-markets booms and busts, to introduce a fund targeting that area. This fund was constructed with the explicit goal of giving investors exposure to the rapidly growing economies of the developing world without having them take on the full risk of the then-extreme volatility of those countries' stock markets. In addition to emerging-markets stocks, the fund stashes a sizable portion of its portfolio in big, household names domiciled in developed markets that do extensive business in emerging markets. A bond portion, which has shrunk over time, was also included to further dampen volatility. The idea was that the likes of Nestle and Toyota would reduce overall volatility, and shareholders would be more likely to hold on for the long term rather than sell when emerging markets stumbled. The fund has performed quite well over the long term. In the recent bear market it outperformed, but given its makeup and aims, one might have expected more. The fund lost 32.1% versus the MSCI Emerging Market Index's 33.7% decline and the diversified emerging-markets category's 34.4% loss.
GQG Partners Emerging Markets Equity GQGIX Lead manager Rajiv Jain had a habit of outperforming in the worst market conditions, often by huge margins, when he ran Virtus Vontobel Emerging Markets Opportunities HIEMX from 2006 to 2016. He's using a similar style at his own shop. He prefers companies with strong market positions that have weathered storms in the past and have manageable debt loads. So, one would expect this fund to provide a cushion in this year's bear market. It did, though not by as wide a margin as shareholders might have hoped given Jain's past record. The fund's Institutional shares fell 30.4%, beating the MSCI Emerging Markets Index by 3 percentage points and the diversified emerging-markets category average by 4 points. (For the year to date through April 16, it's ahead of the category average by 6 points, in the top decile of the group.) Jain's broader offering, Goldman Sachs GQG Partners International Opportunities GSIMX, posted a bear-market loss 7 percentage points milder than the standard international benchmark, the MSCI All Country World Index ex U.S.
First Eagle Overseas SGOIX With typically above-average cash stakes, holdings in gold bullion, and a time-tested, risk-averse equity strategy, this fund should withstand downturns in better shape than most peers and its benchmark. It has done so in the past, and it came through again in the recent bear market. Despite its approach and history, that's a bit of a surprise, because the portfolio's relatively modest market cap and value orientation could easily have worked against it, as both factors were generally detrimental during the downturn. But the Institutional shares' loss of 23.2% during the bear-market period, while substantial, was much milder than the 34.4% plunge endured by the MSCI ACWI ex U.S. and the 33.8% decline of the foreign large-blend average.
A Couple of Disappointments
FPA Crescent FPACX This fund, run by respected and creative manager Steve Romick, is classified by Morningstar in the allocation 50%-70% equity category because it consistently devotes a good portion of the portfolio to asset classes other than equities. One of Romick's key aims is to hold down losses during downturns, and the fund often has done so. This time it hit some bumps. Even with a hefty cash stake, the fund had several disadvantages in this crisis: a very small bond stake compared with allocation rivals, an overweighting in financials, and very low stakes in healthcare and consumer staples. The fund lost 29.1%, nearly 5 percentage points worse than the category average. That said, FPA uses three different benchmarks to measure the fund's performance, and while it lagged the blended stock/bond benchmark, it did lose less than the other two, the all-stock S&P 500 and MSCI ACWI.
FMI International FMIYX This fund has a history of outperforming in tough climates and a wary strategy that focuses on companies with durable business models and impressive profitability. Therefore, one would expect it to have handled the recent bear market better than most. That's especially true because it's one of the few international-stock funds that has a policy of hedging all its foreign-currency exposure to the U.S. dollar, which strengthened during this year's crisis, providing a boost to the fund's returns. But the fund's 37.4% loss was 3 percentage points worse than the MSCI ACWI ex U.S.'s decline and 3.6 points behind the foreign large-blend category average. (FMI uses a more-specialized, all-developed market, local-currency benchmark to measure performance, but the fund lagged that index, too.) A low stake in the relatively buoyant healthcare sector didn't help, nor did the portfolio's value leanings. The fund's much larger-than-average stake in mid-caps was another detriment because, for the most part, mid-sized and small companies lagged far behind the giants as markets sank.
A Pair of Pleasant Surprises
Artisan Developing World APHYX Although the two emerging-markets funds cited above--American Funds New World and GQG Emerging Markets Equity--outperformed in the bear market, they didn't blow away the index and peers. Somewhat to our surprise, this one did. While it's admittedly a stretch to describe a 23.2% loss during this period as pleasant, that was 10 percentage points ahead of the MSCI Emerging Markets Index and fully 11 points better than the diversified emerging-markets category average. Manager Lewis Kaufman does focus on companies with strong balance sheets and has posted good records here and at his previous firm, Thornburg. But this fund's very high valuation multiples, and the fact that it outperformed magnificently in the strong 2019 rally while posting only so-so results in 2018's downturn, make it an unlikely candidate to hold up well during a sharp decline. Yet it did this time. That owes partly to that extreme growth orientation, which proved to be the best place to be in this bear market, and partly to some savvy stock selection, including some picks in developed markets.
Morgan Stanley Institutional Growth MSEQX The story here is somewhat similar to the Artisan fund. For years, lead manager Dennis Lynch and his team have had a strong tilt toward technology and Internet names. The portfolio sports very high multiples and contains its share of unprofitable companies. That's helped the fund achieve a strong long-term record, but those traits also pose quite a risk during market downturns. The fund lagged in the 2007-09 crash and in the fourth quarter of 2018, and its 10-year Morningstar Risk score is worse than the large-growth category average, so it was not a fund we would've expected to outperform when markets tank. But in this bear market, the Institutional shares' 25.7% loss not only was much milder than the Russell 1000 Index's 34.6% decline, but it even substantially outperformed the growth variant of that index, which dropped 31.5%, and the large-growth category average, which fell 31.8%. That demonstrated that the fund's choices--one example being Zoom Video Communications ZM, added late last year--paid off, not just that it happened to be a growth fund in a growth-led market.
 To measure the bear-market performance of the U.S.-focused funds, categories, and indexes, I used the period starting with the day after the S&P 500’s high point through its low point: Feb. 20 through March 23. For the international funds, categories, and indexes, I used Jan. 21 through March 23, as both the MSCI EAFE Index and MSCI ACWI ex U.S. indexes peaked on Jan. 17, and Jan. 21 was the next U.S. trading day.
 FMI International uses the MSCI EAFE Local Index as its primary prospectus benchmark. From the day following that index’s peak to its trough (Feb. 13 through March 23, 2020) the fund lost about 6 percentage points more than the index did. The fund also lagged the MSCI EAFE 100% Hedged Index, during a slightly shorter peak-to-trough period, by 4 percentage points.