Morningstar Magazine - February/March 2015 - (Page 60)

Strategies Preparing for the Worst Downside capture ratios can reveal how your mutual funds will perform when the stock market swoons. INVESTMENT RESEARCH: ACTIVE Russel Kinnel Last year was a rather typical year in the markets-if you managed to tune out some noise. Through December, most asset classes had positive single-digit returns, though some had negative single-digit returns. If you watched the markets more closely, though, you saw a lot of mad rallies followed by mad sell-offs. Some say volatility is returning now that the Fed has brought quantitative easing to a close. If so, then this is a fine time to check in on fund downside-specifically, the downside capture ratio. This measure tells you how much of an index's losses are captured by a fund. Say the S&P 500 loses 10%. A fund that lost 12.5% over the same period would have downside capture of 125%. One that lost 7.5% has downside capture of 75%. That differs a little from Morningstar Risk in two key ways. First, the Morningstar Risk rating is relative to a fund's category, whereas downside capture is relative to a broad index such as the S&P 500, MSCI EAFE, or Barclays U.S. Aggregate Bond indexes. The further you get from those indexes, the greater the difference is and the less helpful the downside capture measure. Second, Morningstar Risk looks at volatility in both directions, though it penalizes losses more, whereas downside capture tells you only about the red ink. The reason for this more holistic view is that volatility on the upside can often later mean volatility on the downside. 60 Morningstar February/March 2015 They also hold cash and gold-mining stocks when the markets look frothy or inflation looks threatening. I worry about management being taxed by a big asset base at a time when comanager Abhay Deshpande has departed. However, with a 22% cash position and 10% in gold, the fund is still a good bet to lose less in the next down market. This fund is closed to new investors, but First Eagle Global SGENX and First Eagle US Value FEVAX remain open. For this article, I sought funds with low 10-year downside capture ratios. Five-year measures wouldn't include the 2008 bear market. I also selected funds in categories where those broad benchmarks are good fits: U.S. large-cap equities, foreign large-cap equities, and intermediate bonds. To ensure I was on the right path, I screened out funds that had high Morningstar Risk and funds that were not Morningstar Medalists. I included funds closed to new investors. Foreign Large Caps First Eagle Overseas SGOVX (50% downside capture ratio) is a name that comes up just about any time you mention low-risk foreign funds. Through a few manager transitions, the fund has stayed true to its mandate of protecting against losses while still growing principal. As shown in EX HI BI T 1 , the fund's losses in the downturn were 26 percentage points less than the MSCI EAFE Index. Management aims to reduce risk by finding good companies trading at sizable discounts to their intrinsic value estimate. Tweedy, Browne Global Value TBGVX (53% downside capture ratio) employs a value-conscious approach that emphasizes healthy balance sheets. The fund avoids big individual stock bets, and its currency hedging also reduces volatility. The style here is modeled on Warren Buffett's idea of paying a fair price for a great company. Virtus Foreign Opportunities' JVIAX (71% downside capture ratio) Rajiv Jain wants growth but on the quality side where companies dominate their industry. He runs a fairly focused portfolio, but that hasn't led to outsized risk. Its large weighting in India makes it unusual on this list as that's one of the riskier emerging markets. U.S. Large Caps First Eagle US Value (59% downside capture ratio) has done a pretty good job on defense (EX HI BI T 2 ), but its offense hasn't lived up to that of its siblings. So, you have to be pretty cautious to see the beauty in this one. Sequoia SEQUX (64% downside capture ratio) is another keeper for those who got in before the doors shut. Following Buffett's emphasis on EXHIBIT 1 Cushioning the Blow Each of these foreign large-cap funds lost significantly less than the benchmark in the bear market. Fund/Ticker Morningstar 10-Yr Downside Analyst Rating Capture Ratio (%) Return % 10/01/07 Morningstar Risk to 02/28/09 Rating Overall First Eagle Overseas SGOVX ´ 50.16 -30.70 Low Tweedy, Browne Global Value TBGVX „ 52.56 -45.88 Low Virtus Foreign Opportunities JVIAX „ 70.84 -49.19 Low MSCI EAFE Index Data as of 12/31/2014. -56.00

Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2015


Morningstar Magazine - February/March 2015