August 2019 IssueLong scroll reading

Overachieving defenders: Your late-cycle shopping list

By David Snowball

Investors are pulled by three competing forces just now.

Force One: The market is going to crash soon enough.

Longest bull market in US history. Valuations, based on 10-year CAPE or Shiller average, have only been higher twice in market history: 1929 and 2000. Record earnings, which make stocks look cheaper, are starting to wobble. Economic policy is being made by tweet by a guy still in his jammies. Trade war. Brexit. $1,200,000,000,000 federal budget deficit this year.

Force Two: There still could be a heck of a party before that happens.

The Fed just cut interest rates for the first time in 3,878 days; rate cuts during past expansions have triggered six month market gains of 11% or so, which would be on top of the 20% YTD gain we’ve already booked.

To be clear: I am not predicting a melt-up and I’m not celebrating what appears to be the Fed’s craven response to political pressures. I’m just trying to fairly reflect factors that seem to be on investors’ minds.

BTW: Our current budget deficit is $1.2 trillion/year. A decade hence, government and private economists estimate that the federal government will be paying $1 trillion/year in debt payments.

Force Three: Investors love them their ETFs!

Fund flows, market dominance, active funds are dinosaurs. Got it.

Here’s the one thing you need to understand: market-weighted indexes work only when the market is rising. If the market falls, you’re toast; first, because you’re developed an almost-religious belief in them and, second, because they fail when you need them most.

We used the MFO Premium screener to look at the performance of all equity and balanced funds and ETFs during the 2007-2009 market decline. Of the 100 investment vehicles with the highest Sharpe ratio, none were ETFs and none were passive funds. Of the 200 best performers, only four were ETFs. Five of the 10 worst performers, by contrast, were passive.

Finding funds to balance your competing desires

MFO maintains two separate ratings systems for mutual funds.

Our main designation is for the Great Owl funds, designated GO in our screener. Here’s the definition: “A fund that has delivered top quintile risk-adjusted returns, based on Martin Ratio, in its category for evaluation periods of 3, 5, 10, and 20 years, as applicable. An MFO 10-year Great Owl (GO) fund, for example, has delivered top quintile risk-adjusted returns for evaluation periods of 3, 5, and 10 years.” The key to understanding the Great Owls is that they are consistently excellent judged by a very conservative risk-return metric.  That means you get a lot of return for the risk you’re exposed to, which doesn’t automatically mean you’re getting a lot of return period.

Our second designation was inherited from our predecessor, FundAlarm. From 1996 on, FundAlarm famously tracked “Alarming” and “Most Alarming” funds based on how consistently miserable their trailing returns were but FundAlarm also maintained an Honor Roll of funds (HR in the screener). Honor Roll funds have returns in the top quintile of their categories in the past 1, 3, and 5 years. That is, Honor Roll funds have consistently high absolute returns, a judgment made without regard to the level of risk they expose their investors to.

In the late parts of a cycle, investors who are unwilling to downshift their asset allocation to include more cash (“dry powder” for use in an eventual fire sale) might want to consider funds that are both Great Owls and Honor Roll members. The following funds:

  • Invest in US stocks or a stock/bond blend
  • Have been around for 12 years or more
  • Have consistently excellent long-term risk-adjusted returns (i.e., are Great Owls)
  • Have consistently excellent short- and mid-term absolute returns (i.e., are Honor Rollees)
  • Are available to retail investors (i.e., have minimums of no more, and generally much less, than $10,000)

As a comparison, we’ve included both Vanguard STAR, a fund of actively managed funds with a 60/40 allocation, and Vanguard Total Stock Market, an ultra-cheap option for getting a bit of everything.

There are 1944 funds and ETFs that have been around for the full market cycle and invest either in US stocks or in a stock/bond blend. Only 13 of those funds – 0.06% – have earned a place on the list below.

The Thirteen Overachieving Defenders

Of the funds listed, Franklin Convertible Securities FundVirtus KAR Small-Cap Core, Virtus KAR Small-Cap Growth, T. Rowe Price New Horizons and T. Rowe Price Capital Appreciation are closed to new investors. Of them, only New Horizons has seen sustained outflows (which might presage re-opening) but New Horizons lost its long-time manager in March, 2019. Other than for investigating the new Virtus KAR Small-Mid Cap Core Fund (VKSAX), the prospect of backdoors and re-openings both seem limited.

Many thanks to MFO reader John Hawrylak, another Western Pennsylvanian, for catching the fact that so many of the best funds are still closed and recommending that we flag them!

  Lipper Category Annual return vs peers Max drawdown Std deviation Sharpe Ratio
Janus Henderson Balanced JABAX Moderate Allocation 7.5 +2.8 -21.5 9.1 0.76
T Rowe Price Capital Appreciation PRWCX Growth Allocation 8.9 +3.8 -36.5 11.4 0.73
T Rowe Price New Horizons PRNHX Mid-Cap Growth 13.5 +5.6 -49.9 18.3 0.71
Parnassus Core Equity PRBLX Equity Income 9.8 +3.5 -35.6 13.4 0.69
AMG Yacktman Focused YAFFX Large-Cap Value 10.8 +5.0 -38.3 14.9 0.69
LKCM Balanced LKBAX Growth Allocation 7.2 +2.1 -27.5 10 0.67
Jensen Quality Growth JENSX Large-Cap Core 9.2 +2.1 -41.1 13.8 0.63
Touchstone Balanced SEBLX Growth Allocation 6.4 +1.3 -33.3 10.1 0.58
Columbia Dividend Income GSFTX Equity Income 8 +1.7 -43.3 13.1 0.57
FAM Dividend Focus FAMEX Equity Income 8.8 +2.4 -46.2 15 0.54
Franklin Convertible Securities FISCX Convertibles 7.8 +2.0 -43.3 13.6 0.53
Vanguard STAR VGSTX   6.1 +0.9 -35.6 10.7 0.51
DF Dent Premier Growth DFDPX Multi-Cap Growth 9.2 +1.0 -54.5 17.8 0.48
Vanguard Total Stock Market VTSMX   7.9 +1.4 -50.9 15.7 0.47
MFS Aggressive Growth Allocation MAAGX Aggressive Growth Alloc. 5.9 +1.3 -51.6 15.6 0.34

MFO Premium search: Sub-type = US equity or mixed asset, Great Owl = yes, Honor Roll = yes, Period = Full Cycle 5 (2007-present), Minimum purchase < $10,000. Data current as of 6/30/2019. Sorted by Sharpe ratio.

Here’s a one-time special offer: if you’d like more detail on any of the Defensive Overachievers, drop us a note and let us know. If any fund interests more than two readers, we’ll produce a full profile of the fund for you!

But wait, there’s more! We’ll happily share word of, and thoughts behind, your nomination of the fund with next month’s readers. It’s like being famous without the hassle of paparazzi!

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About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.