Morningstar Magazine - February/March 2015 - (Page 60)
Preparing for the Worst
Downside capture ratios can reveal
how your mutual funds will perform
when the stock market swoons.
INVESTMENT RESEARCH: ACTIVE
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.
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
Cushioning the Blow Each of these foreign large-cap funds lost significantly less
than the benchmark in the bear market.
Analyst Rating Capture Ratio (%)
Return % 10/01/07 Morningstar Risk
First Eagle Overseas SGOVX
Tweedy, Browne Global Value TBGVX
Virtus Foreign Opportunities JVIAX
MSCI EAFE Index
Data as of 12/31/2014.
Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2015
Morningstar Magazine - February/March 2015