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Shelter From the Storm

Steven Goldberg

Leuthold Asset Allocation fund offers a fine way to lower risk when stocks sink. It might be just the thing for this market.



Looking for shelter in a volatile market? Leuthold Asset Allocation fund may be just the ticket. Funds that try to outguess the market usually fail miserably, but this one may well beat the odds. Just remember: There's almost nothing conventional about the fund -- or any other Leuthold fund, for that matter.

I don't think anyone can time the ups and downs of the stock market successfully enough to outperform a simple buy-and-hold strategy. But the returns of Minneapolis money manager Steve Leuthold's funds and of his firm's private accounts challenge my view. I wouldn't make Leuthold Asset Allocation (symbol LAALX) a core holding. But making the fund 10% to 15% of your portfolio could dampen volatility, reduce the pain of bear markets -- and, with luck, not hurt your long-term returns. Most important: You'll sleep better at night even if the market remains turbulent.

A good record

Leuthold has been studying the markets for a living for more than 40 years. Rather than looking at a couple of factors to predict which way stocks will head next, he tries to examine everything. His firm's "major trend" model contains 190 factors, ranging from mutual fund inflows to inflation data.

His recent record is impressive. He called the start of the bull market that began in October 2002, and he was almost perfect in predicting the onset of the market's downturn last July. He's far from infallible, of course: In 2005, for instance, he incorrectly signaled the start of a market decline.

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His funds are all quantitative. That is, Leuthold and his colleagues program computers to look for attributes common to stocks that should rise -- such as low price-earnings ratios, insider share buying, as well as more esoteric indicators. All the funds are team managed, with all of the firm's professionals contributing, says Eric Bjorgen, a Leuthold analyst.

Their records are good. The oldest, Leuthold Core Investment, returned an annualized 12% since inception in 1995 through the end of August-an average of one-half percentage point per year more than Standard & Poor's 500-stock index. It lost a mere 5% in the 2000-2002 bear market, during which the S&P 500 plunged 47%.

Core Investment is closed to new investors. However, Asset Allocation, launched last year, is similar. Both funds take their cues on what percentage to invest in stocks from the same major trend model. Some of the stockpicking for the new fund is based on a different, but equally successful Leuthold system. These funds won't perform identically, but their numbers probably won't differ widely either. Negatives: Asset Allocation's annual expense ratio of 1.73% is high, and the minimum initial investment is $10,000.

Asset Allocation is currently net 33% in stocks. It gets there, natch, in an unconventional way. It has 57% of assets in stocks and 24% in other stocks that have been sold short. A short sale is a wager that a stock will fall.

A conservative approach

Asset Allocation has other atypical holdings. The fund has 5% in notes linked to the price of industrial metals such as aluminum, copper and zinc. Eight percent is in cash, 5% is in bonds and 1% is an exchange-traded fund that tracks the price of silver.

Leuthold has been bullish for several years on industrial metals -- so much so that he actually bought the metals themselves, rather than the stocks, and stored them in warehouses. Unfortunately, commodities broker Refco Inc., which held some of the metals for the Leuthold funds, went bankrupt. The funds have recovered most, but not all, of the money they were owed.

Despite his unorthodox methods, Leuthold's humility and caution stand out. Many short sellers like to borrow money to magnify their bets; Leuthold's funds never employ leverage. Similarly, most market timers go 100% to cash when they're bearish. Leuthold insists on holding at least 30% in stocks-and never more than 70% in stocks. I like the conservatism that policy represents.

Leuthold and his colleagues are canny veterans. As a longtime fan of his green-covered monthly market report, I trust him not make huge mistakes. In short, the funds may well trail the market, but they won't get you killed.

A riskier beast

That is, most of them won't. One might: Grizzly Short (GRZZX). This fund puts essentially all its assets into short sales on stocks. The fund's first two calendar years were terrific. It returned 22% in 2001 and 16% in 2002.

Then the roof fell in. With the market rising, Leuthold's models weren't good enough to pick falling stocks. The fund is flat so far this year, but lost money in each of the previous four years. Over the past five years, the fund has lost 13% annualized.

But analyst Bjorgen says that's looking at the fund the wrong way. He argues that you need to compare the fund's performance against how you would have done if you had sold short all available stocks in the S&P Midcap 400 index. He uses that index since the fund shorts stocks mostly of midsize companies.

A composite of Grizzly Short's approach -- not the fund, but Leuthold's numbers for its own accounts without deducting fees -- shows a loss of an annualized 3.5% since 1998 through the end of July. Wretched? Yes, but had you shorted the S&P Midcap 400, you would have lost an annualized 18% during the same period.

If you want to insulate your portfolio against a market decline without selling your holdings -- a strategy you might consider for tax reasons -- you could justify putting 5% of your money in Grizzly Short. The problem, of course, is that the market generally goes up. Thus, if you're concerned about a selloff, a simpler solution is to just sell some stocks or stock funds.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.




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