Funds That Thrive in Uncertain Times? Yes
Worried about what 1999 might bring? You’ve got good reason--and a lot of company.
Stock valuations based on price-to-earnings ratios are at historic highs. Internet stocks and the 250 or so largest blue-chip shares just had a good year, but not so the rest of the stock market.
No doubt about it, these are uncertain times. So we set out to identify those mutual funds that thrive in times like these.
We started with fund tracker Morningstar Inc.’s database of the 4,770 stock funds still open to retail investors, then applied several screens to produce a list of diversified funds that have exhibited the best risk-reward characteristics.
First, we considered something called the Sharpe ratio, a mathematical calculation developed by Nobel Laureate and Stanford professor of finance William Sharpe that measures how much reward an asset delivers per unit of risk. The higher the ratio, the better the investment. The typical U.S. stock fund sports a Sharpe ratio of 0.70, so we decided to screen for funds with ratios at least twice that--1.40.
Then we looked at two other risk measures that may be familiar to you. One is beta, a number that indicates how volatile an asset is relative to the appropriate market benchmark. For instance, a large-cap stock fund whose beta is 2.0 tends to rise twice as much as the benchmark Standard & Poor’s 500 index when stocks go up, and to lose twice as much when the S&P; falls.
Our next step, then, was to eliminate all funds whose beta was higher than that of the average domestic stock fund.
Then we looked at the standard deviation, which indicates how much a fund’s returns vary over time. A fund that delivers 30% gains in one year followed by 20% losses the next will have a much higher standard deviation than a fund that consistently gains 10% a year. We screened out every fund whose standard deviation was higher than the average for its peers.
Those screens left us with 23 funds. We then considered performance, eliminating all funds that didn’t beat at least 90% of their peers over the past one and three years. Finally, we tossed out all funds that Morningstar considers riskier than its peer-group average and whose performance Morningstar considers below its peer-group average.
This left us with 10 funds suitable for uncertain times such as these:
Large-Cap Funds
* Ameristock (no load; minimum initial investment: $1,000; [800] 394-5064; 1998 return: 31.1%). Think of this $40-million large-cap portfolio as an index fund that manages risk. Ameristock holds most of the largest stocks in the blue-chip S&P; 500 index (and these are the stocks that have led the index of late). But rather than putting most of the money into the biggest capitalization stocks, as S&P; 500 index funds do, manager Nicholas Gerber puts more money into those stocks that he considers safer and better values, based on traditional measures such as price-to-earnings ratios and dividend yields.
* Clipper (no load; minimum initial investment: $5,000; [800] 776-5033; 1998 return: 19.2%). The three managers of this $1.3-billion fund aren’t afraid to hold a lot of cash when they can’t find good stocks selling for considerably less than what they think they’re worth. In August, for instance, the fund was holding as much as 40% of its assets in cash.
* Fidelity Dividend Growth (no load; minimum initial investment: $2,500; [800] 544-8888; 1998 return: 35.9%). This $9.5-billion fund is willing to buy stocks trading at high P/Es so long as their earnings growth rates are even higher.
* Nationwide (4.5% load; minimum initial investment: $1,000; [800] 848-0920; 1998 return: 30.6%). This $2.2-billion large-blend fund has beaten more than 91% of its peers over the past one, three, five, 10 and 15 years. Yet because manager Charles Bath seeks out consistent performers, such as Fannie Mae, rather than chasing the hot stocks of the moment, the fund is 37% less risky than its peers, according to Morningstar.
Mid-Cap Funds
* Weitz Value (no load; minimum initial investment: $25,000; [800] 232-4161; 1998 return: 29.0%). Manager Wally Weitz is giving Warren Buffett a run for his money for the title of Sage of Omaha. Employing his classic-value approach to investing, both of Weitz’s two stock funds are beating more than 97% of their peers over the past one, three and five years.
* American Century Equity Income (no load; minimum initial investment: $2,500; [800] 345-2021; 1998 return: 13.0%). This $330-million fund uses a time-honored technique to identify undervalued and safe stocks: It sticks with stocks with higher-than-average dividend yields. So when the S&P; 500 sank in August, American Century Equity Income dropped only a fifth as much, Morningstar analyst Scott Cooley notes.
* MAP-Equity (4.75% load; minimum initial investment: $250; [800] 559-5535; 1998 return: 24.3%). This $96-million mid-cap fund “is a cautious investor’s security blanket and a stock enthusiast’s dream,” Morningstar analyst Amy Granzin says. MAP-Equity reduces risk by splitting its stock-picking and research responsibilities among three managers. And this is another fund not afraid to keep a sizable cash position if market conditions warrant it.
Hybrid Funds
* Preferred Asset Allocation (no load; minimum initial investment: $1,000; [800] 662-4769; 1998 return: 27.1%). This $204-million asset-allocation fund manages risk by splitting its assets 50-50 between two managers of differing styles: Tom Hazuka of Mellon Capital Management and Ed Peters of PanAgora Asset Management.
For instance, Hazuka started 1998 with 60% of his holdings in stocks, whereas Peters began the year with no stock exposure and 40% of his money in cash, Morningstar’s Granzin says.
* McM Balanced (no load; minimum initial investment: $5,000; [800] 788-9485; 1998 return: 20.8%). This $104-million team-managed fund takes both a bottom-up (i.e., it investigates the fundamental characteristics of each stock and bond) and top-down (i.e., it studies the prospects for the sector in which a stock or bond resides) approach to managing risk for its stock and bond holdings.
* Mentor Balanced (5% deferred load; minimum initial investment: $1,000; [800] 382-0016; 1998 return through Nov. 30: 19.4%). By sticking with only the highest-quality bonds and undervalued large-cap stocks, this $11-million balanced fund has managed to beat at least 95% of its peers over the past one and three years, while remaining 61% less risky, according to Morningstar.
