Mutual Funds
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5 bubble-proof funds
After the Nasdaq peaked five years ago, plenty of mutual funds tanked. Here are five that survived and even thrived, thanks to the stock-picking skills of their managers.
By Timothy Middleton
Call them the anti-bubble funds.
They're the funds that dodge the bullets for you, whose managers know when not to chase returns and when to pick up bargains.
And they've proven their worth in the five years since the Nasdaq Composite Index ($COMPX) peaked at 5,048. Since then, that index is down nearly 60%. The S&P 500 Index ($INX) is still off 12.4%.
Plenty of mutual funds have bucked the market's decline and delivered positive returns during that period. But many are in specific categories -- gold, real estate, emerging markets -- that aren't exactly the best places to put big chunks of your investment portfolio.
The funds we've picked have results due less to the performance of a niche sector and more to the stock-picking skills of the managers. While the indexes have swooned, these funds have gained as much as 15% a year.
Some of the funds are openly contrarian. One of these, Fidelity Contrafund (FCNTX), has this notion in its name.
The names of the other four don't single them out for attention, but their success in this market does. Not all of them are conservative, either: Perritt Micro Cap Opportunities Fund (PRCGX) has plenty of risks of its own.
RS Value Fund (RSVAX) -- formerly called the RS Contrarian Value Fund -- also invests in riskier small names. Gateway Fund (GATEX) sacrifices most of its upside potential to protect capital. Vanguard Asset Allocation Fund (VAAPX), as its name suggests, is designed to capture returns from stocks and bonds, and hopefully more from whichever is performing best at the time.
At least one of these funds could find a permanent home in nearly every portfolio. Indeed, these are not trading vehicles, as gold funds are.
Living large, with help from the small
Fidelity Contrafund: I wrote about this fund most recently only four months ago. Since then it has continued to benefit from substantial holdings in foreign companies and energy stocks, while maintaining broad diversification among more than 500 individual issues.
Manager William Danoff is what nearly all fund managers claim to be, but aren't: a stock picker. His portfolio is far from a clone of the S&P 500; the share of its returns due entirely to the performance of the fund's benchmark index is a slender 63%. The fund is one-third less volatile than the index, as well, meaning investors don't have to suffer through wild ups and downs in order to enjoy the fund's exceptional long-term returns.
Perhaps Danoff's most remarkable feat is managing to invest nearly a third of Contra's $44.41 billion of assets in small and mid-cap stocks, which, by their nature, have a reduced sensitivity to movements in big-cap issues. In the 10 years ended Jan. 31, the fund's annualized returns were 13.8%. Its biggest bear-market loss was 12.6% in 2001, when the average fund of its type tumbled 21.4%.
Smooth sailing, with an upside
Gateway Fund: This fund's goal is specifically to limit price volatility, which means it goes up less in bull markets and down less in bears. In 1999 it went up 13%, which lagged the broader market. But its biggest loss in the last decade was 4.9% in 2002, a year in which the market plunged 22.1%.
It gets such steady returns by selling call options on the S&P 500, basically forfeiting potential market gains in return for fee income. It uses one-third of that cash stream to buy put options on the index, which profit if the market goes down.
Because of its focus on the index, the fund has a relatively high correlation to the market. Its volatility, however, is half that of the market's. The result over the last 10 years has been annualized gains of 7.2%. Morningstar analyst Dan McNeela says the fund "accomplishes its mission" of avoiding volatility "that can keep stock investors from getting a good night's sleep."
Good fund, new manager, better returns
Perritt Micro Cap Opportunities: I profiled this fund in the summer of 2001. Since then, the fund has grown from $10 million to $285 million.
In November 1999, Gerald Perritt began passing the job of portfolio manager to Michael Corbett, who has done a far better job than Perritt. The fund actually fell 8.2% in the last year of Perritt's tenure. But since then it has delivered positive calendar-year returns, as when it rocketed ahead 34.5% in 2001.
Corbett, who looks for companies with good balance sheets and the potential to grow at a 20% to 25% clip, says he'll close the fund when assets rise to between $300 million and $400 million. Already his record has attracted so much money he's currently unable to invest about 14% of total assets. Corbett invests in very small companies, with market capitalizations of about $200 million.
Corbett spreads the fund's investments over 150 names, but his fund's volatility, as measured by standard deviation, is slightly above his group's average. Small stocks are risky, not least because it can take weeks or even months to get into or out of positions in this thinly traded marketplace. Morningstar analyst Karen Papalois argues Corbett's winning streak can't last forever and counsels, "It can be a useful addition to a portfolio, but only in small doses."
A well-timed foray into resource stocks
RS Value: This superb fund has the same management as RS Partners (RSPFX), which is closed. This portfolio is still open because it invests in companies with an average market capitalization of $4 billion, rather than $1 billion in the Partners fund.
RS buys out-of-favor stocks -- hence its former name, RS Contrarian Value Fund -- with improving cash flows in attractive sectors. The top names at the end of last year, the most recent reported, were dominated by natural-resources companies including Alcan (AL, news, msgs), The St. Joe Company (JOE, news, msgs) and Peabody Energy (BTU, news, msgs).
This fund's focus on small companies makes it a closer fit with small-cap funds, but it doesn't perform like the typical small-cap fund. RS Value's standard deviation is below average, and its five-year returns average 18.3%.
Shifting bets between stocks, bonds
Vanguard Asset Allocation: Vanguard has built its reputation on indexing, and this fund's stocks are indexed to the S&P 500 and its bonds to the Lehman Brothers Long Term Treasury Index. But unlike the typical index fund, it doesn't invest and forget. As the name suggests, it is free to alter asset allocation at will, from 100% cash to 100% equities and anything in between.
As of the most recent reporting period, the fund was 83% invested in U.S. stocks, a little more than 9% in bonds and 7% in cash. It boosted its stock hoard in last year's fourth quarter, a very timely move because the market generated all its annual return in those three months. But the bonds helped, too: Last year's return of 11.1% edged out the market by 0.22%.
Manager Thomas Loeb has made adroit asset-class shifts over the years. The fund beat the market by wide margins in 2000-2002, and over the last 10 years returned 11.5% annually, exactly as much as the S&P 500 in the same period. That means Loeb earned enough to erase the effects of the fund's 0.38% expense ratio.
If we are in, as I and many others believe, a long-term bear market, funds like these will do a much better job of preserving shareholder capital than the vast majority of their rivals, including index funds.
The only time they won't shine is during raging bulls, like 1999. But that's what makes them anti-bubble funds.
At the time of publication, Timothy Middleton owned or controlled the following securities mentioned in this article: Fidelity Contrafund.
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