At a time when nearly everything has gone wrong in the investment world, buying mutual funds that stick to their knitting has been a resounding disappointment. Last year, for instance, a majority of the equity funds that pursue eight of the nine traditional investing styles tracked by Standard & Poor's — from small-cap value to large-cap growth — fared worse than the benchmark S&P 500 Index, which tumbled 39 percent.
That performance goes a long way toward explaining the flurry of new fund launches from money managers like Putnam Investments, ING Funds, and Goldman Sachs, among others, that promise to deliver “absolute returns” in any market environment by trading options and futures or shorting stocks, a technique that enables the manager to make money when shares decline.
“A lot of these funds start proliferating during times of economic crisis,” says Morningstar analyst Nadia Papagiannis.
But be careful: As CBS MoneyWatch.com has reported elsewhere, absolute-return funds can be pricey, require a big minimum investment, and pack a tax wallop as a result of frequent trading. The strategies also tend to be complex, and performance, if there is a track record at all, can vary widely.
Fortunately, you can reap the rewards of hedge-fund-inspired strategies without buying into potentially expensive and opaque absolute-return funds.
“A growing number of traditional funds are adopting alternative investment techniques as they strive to manage risk and find additional sources of returns,” says Rick Lake, co-founder of Lake Partners in Greenwich, Conn., an investment adviser who has been tracking these funds for more than a decade.
What Are They?
The go-anywhere, do-anything funds are hard to identify, but can typically be found in Morningstar’s large blend, moderate allocation, or world allocation fund categories. Look under “Investment Strategy,” in a Morningstar.com summary or the fund’s prospectus for a highly flexible investment approach — one that permits the manager to own stocks or bonds in the U.S. and abroad, sell short, dabble in options or commodities, and raise a lot of cash when necessary to protect capital. That freedom may give these funds the flexibility to find the investments set to benefit when the economy recovers — as well as the freedom to find safe havens if the economy sinks some more.
“When the market does poorly, the funds will provide downside protection,” says Lou Stanasolovich, president of Legend Financial Advisors in Pittsburgh. “They can also outperform the market.”
But you have to understand the bet you’re making. They tend to depend heavily on the skills of the managers running them. Few fund managers have the ability to excel in many different markets, and a manager who departs from the investing herd can, by definition, do much worse than average as easily as much better.
Four Funds to Consider
If you’re still interested, then take a look at these four funds. We chose them because they have the attributes you want in this kind of strategy: low fees (why go with a fund that charges you more for comparable investing talent?); a seasoned manager (more than in most funds, you depend on the leader’s skill); and a deep pool of talented researchers (because no one manager can be an expert in every market).
BlackRock Global Allocation Fund
Lead Manager Dennis Stattman, bolstered by a highly experienced team, has been managing this fund since 1989. Stattman invests in the stocks and bonds of companies located in almost every region of the world and reduces downside risk with limited short-selling — less than 1 percent of the fund’s stock holdings are short right now, for example — as well as some use of futures, options, and even credit default swaps.
Pluses: With an expense ratio of 1.14 percent, which is in line with traditional actively managed mutual funds, you get a lot of flexibility and global expertise for your buck.
Pitfalls: The minimum investment is a reasonable $1,000, but if you invest less than $25,000, you’ll have to pay a 5.25 percent front-end sales charge — unless your broker or 401(k) plan waives it.
Performance: Last year the fund was down, but it lost only about half as much as the S&P 500. In the five years ending June 19, the fund delivered an average annual return of 7.0 percent, versus a loss of 1.9 percent for the S&P 500 over the same period. This year, the fund is up 6.1 percent.
JPMorgan U.S. Large Cap Core Plus Fund
This relative newcomer, launched in late 2005, uses a so-called “short extension” strategy in which the fund manager sells a basket of stocks short and uses the proceeds from the sale to “go long” (i.e., buy more stocks). Short-extension funds typically rely on computer models and have mostly been a bust, but this fund — which dumps the computer in favor of fundamental analysis by human analysts — is a rare gem.
Pluses: JPMorgan has been shorting stocks in its institutional funds for almost two decades, and boasts a strong equity research team of 20 sector analysts. The minimum investment of $1,000 and the expense ratio of 1.25 are both low.
Pitfalls: Given its strategy, lead manager Tom Luddy must have 100 percent exposure to the market at all times, so he can’t raise cash in choppy markets.
Performance: The fund outperformed the S&P 500 by a wide margin in 2006 and 2007. Last year it lost money but still did better than the index. This year through June 19, Luddy is up 9.6 percent — and is outpacing the benchmark.
FPA Crescent Fund
Skippered by well-regarded manager Steve Romick, this 16-year-old fund invests in stocks and a variety of bonds and other fixed-income assets. To keep a lid on risk, Romick occasionally shorts stocks and often puts a good chunk of the portfolio in cash. For the first time ever, Romick is holding more bonds than stocks, a sign he’s nervous about the latter.
Pluses: The fund’s returns tend not to track those of its major competitors. In other words, when the stock market is zigging this fund can zag, making it a great portfolio diversifier.
Pitfalls: Because he keeps so much money in bonds and cash, Romick may not catch all the upswing in the stock market as the broader economy strengthens.
Performance: Last year was tough, but Romick’s longer-term performance is solid. In the trailing five years through June 19, he delivered an average annual gain of 4.5 percent. So far this year, he’s up a healthy 12.2 percent.
Ivy Asset Strategy
This fund scoops up the stocks and bonds of companies from around the globe, but it also lines its portfolio with less-traditional asset classes such as commodities and currencies. Managers Michael Avery and Ryan Caldwell occasionally sell stocks short. For some time, the fund has favored gold and China as emerging-markets plays.
Pluses: The co-managers have proven their ability to protect capital in times of market duress over the past decade. The minimum investment is just $500.
Pitfalls: Their wide-ranging mandate and interest in volatile emerging markets could backfire.
Performance: Although the fund suffered losses last year, double-digit returns in prior years help boost its trailing five-year annual total return to a very respectable 13.4 percent. This year through June 19, the fund is up 6.6 percent.