All too often, mutual fund prospectuses feel eerily like those medicine commercials that have endless lists of potential side effects. The only difference, it seems, is that while both mutual funds and medications have led to plenty of unanticipated cases of headaches and profuse sweating over the past year, mutual funds have been more likely to wipe out your retirement savings in the process.
As these deep losses pummeled investors' bottom lines, they also shattered the notion of the "safe" stock fund. "In the previous bear market, you had pockets of strength so that a number of stocks and a number of stock funds still made money," says Russel Kinnel, Morningstar's director of mutual fund research. "But in '08, [that was] virtually impossible."
Still, not all stock funds are created equal, and some are obviously safer than others. With that in mind, U.S. News set out to find three U.S. equity funds that have proved their ability to generate strong returns over long periods. Notably, the three listed below pass the following screens: Each is in the top 20 percent of its Morningstar category for the trailing 10 and 15 years, has an expense ratio and three-year standard deviation (a measure of volatility) below its category averages, and receives Morningstar's "low risk" rating.
While these funds have demonstrated their worth over the years, they have not all held up particularly well in 2009. Year to date, for example, BlackRock Equity Dividend and Jensen J are both in the bottom halves of their Morningstar categories. Broadly speaking, this points to a trend that has hampered a number of quality funds. "This year has kind of been the mirror image of last year," says Kinnel. "Some of the high-quality funds and some of the ones that really emphasized defensiveness are now lagging this year." Still, this is beginning to change. "Since September, things have kind of normalized, and we're finding that quality counts again," says Equity Dividend comanager Robert Shearer. And with quality in mind, here's a look at the funds:
The Investment Company of America (AIVSX). For this fund, history has come full circle. Created in 1934 as the economy staged a comeback from the worst of the Great Depression, the fund now finds itself in a similar market and is counting on the same tried-and-true methods that have allowed it to succeed for more than seven decades. Overall, the fund, which is part of the American Funds family, has profited from its focus on strong blue chips and its preference for dividends. It also has some cash and bond exposure to soften the portfolio. This margin of safety came in handy during the downturn, when the fund beefed up on its cash holdings to check against tumbling stock prices and provide extra liquidity.
Jensen J (JENSX). This fund's cautious strategy says it all. Within its highly concentrated portfolio—it contains around 25 names at any given time—its focus on quality is undeniable. Notably, the fund will consider only companies that pass its screens, the most important of which is that each company needs to have produced returns on equity of at least 15 percent in each of the past 10 years. Beyond that, companies must have market capitalizations of at least $1 billion. Because of these screens, the fund's universe is limited even in strong markets, and it shrank even further as the downturn made it harder for companies to produce returns on equity. "While over the last two years the universe has declined from a peak of 184 [companies] two years ago to 150 today, we're anticipating that that's about as far down as it will go, and then it will start to rise again," says comanager Robert Millen. Within the companies that meet its numeric criteria, the fund looks for the most innovative and financially healthy.
BlackRock Equity Dividend (MDDVX). In keeping with its name and prospectus, the fund puts its assets in dividend-paying stocks as a way to minimize volatility. Beyond that, the fund looks for companies with strong balance sheets. "We try to mitigate the downside element by having that balance sheet strength," says Shearer. "That's actually helped our portfolio weather some of the cyclical downturns." Like the Investment Company of America, BlackRock Equity Dividend benefited from having a portion of its portfolio in cash during the recession. Over time, the fund's buy-and-hold mentality, evidenced by its 7 percent turnover rate, has also been conducive to steady returns.