Which Did Better Last Week? Wrong Question

Last week provided investors with a firsthand and sometimes scary reminder that different types of stock mutual funds behave differently in falling markets.

When the market overall tumbles, aggressive funds tend to drop faster than average, though they tend to recover more quickly too. Conservative funds tend to behave in the opposite fashion, falling less quickly than average but also recovering more slowly.

Let’s look at what happened to two kinds of funds, each of which has performed better than the average general U.S. stock fund in this bull market:

* The Aim Constellation Fund of Houston ([800] 347-4246), which invests in mid-sized growth stocks and earned 177% in the five years ended Sept. 30.

* The more conservative, value-oriented Clipper Fund of Beverly Hills ([800] 776-5033), which earned 150% in the same period.

On Monday of last week, AIM plunged 8.4% in value, more than the 6.7% drop in the Standard & Poor’s 500-stock index. Clipper fell only 3.6%.

During the rebound last Tuesday, when the S&P; 500 gained 5.1%, AIM also gained 5.1%, whereas Clipper gained only 3.1%.

Year-to-date through last week, AIM Constellation is up 16%; Clipper is up 23%.

Analysts say the two funds’ performance last week should underscore to investors that bull markets don’t last forever and that each investor must always consider what level of risk he or she can stomach, in both a falling and a rising market.

“I hope that this opens people’s eyes to the notion that the market can go up or down, and that they [should] try to anticipate what kind of fund they want to be in in the bad times and the good,” said Jeff Walker, an analyst in Denver who publishes the Walker Market Letter on the Internet.

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Which fund did better last week? There’s no one right answer, analysts say, because it all depends on an investor’s expectations and tolerance for risk and volatility. “They both did what they said they would do,” Walker said. “You can’t do better than that.”

In Aim’s case, the fund’s promise to investors is to be “fully invested”--which means holding no cash--in growth companies with a market value of between $300 million and $1 billion, said Robert Kippes, senior portfolio manager of Aim Constellation.

That means the fund focuses on technology, health-care and retail stocks--securities that as a group have done well during the bull market of recent years. But many of those issues, especially those in the tech sector, also tend to be volatile and can fall much faster than other stocks in down markets.

“But we also bounce back quicker,” Kippes said. On Tuesday of last week, “we took off like a big bird.”

Clipper has a very different strategy. “We didn’t have any holdings in the currently thrilling technology groups favored by the markets recently,” said James H. Gipson, co-manager of the Clipper Fund.

What’s more, whereas Aim Constellation stays fully invested, Clipper takes a more cautious tack: If he can’t find enough stocks that he believes are cheaply priced, Gipson will simply allow the fund’s cash balances to build up.

In fact, about 25% of Clipper’s assets now are in cash, the most conservative investment possible, “and cash obviously helped” break Clipper’s fall last week, Gipson noted.

In addition, about 12% of the fund is invested in zero-coupon U.S. Treasury bonds, which makes the fund a beneficiary when long-term market interest rates drop, as they did last week.

And although 62% of Clipper’s portfolio is in stocks, the fund’s value orientation keeps it focused on issues that often decline less sharply in market pullbacks.

About 20% of the fund’s stock portfolio is in shares of Fannie Mae and Freddie Mac, the two titans of mortgage finance. Other holdings include McDonald’s and Wal-Mart Stores, Gipson said.

Falling less than the S&P; 500 meant Clipper had “gone a long way to preserving shareholder capital,” Gipson said. “The most important decision as a fund manager is not what you invest in, but avoiding areas of the market that are most speculative and overvalued.”

Still, the two funds’ five-year performance figures would seem to suggest that even if it takes more risk, Aim Constellation also has provided higher returns over time. And over the last 10 years, the Aim fund has gained 410%, compared with Clipper’s 345%.

If nothing else, last week ought to give fund investors the impetus to simply take a closer look at the funds they own and to decide if they truly fit their risk profile.