Investors who foresee an end in the decade-long rally in U.S. stocks may want to shift some money to mutual funds that do best in rockier market periods.
Value Line Inc. found six funds that weathered the stock market crash of 1987, the declining market of 1990 and last summer's market plunge: USAA Income, Vanguard Wellesley Income, Vanguard Preferred Stock, Pax World, Chase Balanced and Founders Balanced.
"They're funds that offer upside potential and also should hold up well when the market goes south," said Reuben Brewer, the Value Line analyst who did the study.
The funds share a conservative bent, either because they buy preferred stock and bonds, use options to hedge market risk, or concentrate investments in stocks such as real estate investment trusts that pay above-average dividends, Brewer said. The investing approach has meant sub-par returns for these funds during the long-running stock market rally, he said.
It may seem misguided to look for ways to reduce exposure to stocks during a period when they're recording the highest relative returns for investors. Still, it's important to remember that bull markets haven't lasted forever.
The standout performer in the falling markets of 1987, 1990 and last summer was the $1.5 billion USAA Income Fund, which tends to have less money invested in stocks and more in bonds.
Others on Value Line's list that are categorized as "income" funds are Vanguard Wellesley Income and Vanguard Preferred Stock. Pax World, Chase Balanced and Founders Balanced are "balanced" funds and generally have a larger portion of assets invested in stocks than bonds.
The USAA fund gained 1.2 percent from Aug. 1, 1987, through November 1987, a period when the average stock and "mixed asset" fund slumped 26.1 percent, Brewer said. In the five-month period ended Oct. 31, 1990, the fund rose 3.4 percent, a spell when the average stock and mixed asset fund fell 15.1 percent.
Last summer the USAA fund rose percent during a period when rival funds declined 13.7 percent.
The USAA fund, managed by John Saunders, concentrates assets in mortgage-backed securities and sprinkles the portfolio with shares of REITs. It's a conservative approach that has limited returns in recent years.
USAA Income rose at an annual rate of 7.9 percent over the past three years, or less than one-third the annual gain of the Standard & Poor's 500-stock index, the U.S. stock market benchmark.
Last June, Value Line compiled a similar list of funds to buy "when the sky is falling." One of the 15 spotlighted by Value Line--Greenspring Fund--failed to hold up well when stocks tumbled last summer. Another, Analytic Defensive Equity, also slumped, though the fund's manager said the decline was in line with expectations.
Greenspring Fund fell 19.6 percent in the three-month period ended Sept. 30 because of hefty investments in shares of smaller-sized U.S. companies that were especially hard hit during the market decline. The drop was 6 percentage points worse than those of rival funds, according to Value Line.
The fund still has 55 percent of assets in stocks, much of which is invested in small-cap stocks, said Chip Carlson, manager of the $87 million Greenspring Fund. "The small-cap part of the market is where the best values are," he said.
The fund is more defensively positioned than last summer because "we're invested in companies that are much stronger financially than some of the companies we owned last year," Carlson said.
Greenspring Fund is up 3.2 percent this year.
Analytic Defensive Equity Fund fell 6.2 percent in the three-month period ended Sept. 30, a period when the S&P 500 declined almost 10 percent.
"We've historically fallen half what the market has during rough times," said Dennis Bein, co-manager of the $65 million Analytic Defensive Equity Fund.
Bein stays away from making market bets. Instead, he uses options to hedge the fund so it doesn't keep pace with the market when stocks are rising and it doesn't fall as much as the market when stocks are declining.
While both Analytic Defensive Equity and Greenspring performed as their managers anticipated, neither is included in Value Line's latest "where-to-hide" list.