The second of Steve’s five favorite low-risk stock funds: T. Rowe Price Capital Appreciation makes good money in bull markets. By Steven Goldberg, Contributing Columnist September 6, 2011 Note: Most investors couldn't care less about beating the market. They want solid returns from funds that will hold up well in awful markets. This is the second of five columns on my favorite low-risk stock funds.The recent market selloff has been a tonic for David Giroux. He has boosted the stock allotment in T. Rowe Price Capital Appreciation (symbol PRWCX) from less than 65% three months ago to 70% today, while cutting the fund’s cash position in half, to 7.5% of assets. And he’s loading up on beaten-down industrial stocks. “We’re optimistic when others are pessimistic,” says Giroux, who has piloted the fund since 2006. “The totality of the evidence today is that stocks are really cheap.” SEE ALSO: Our Guide to Mutual Funds Capital Appreciation is an unconventional but superb low-risk fund. Price has run the fund successfully for 25 years. Over the past five years through September 2, the fund returned an annualized 3.6%, compared with an annualized 0.1% for Standard & Poor’s 500-stock index. Yet the fund was 19% less volatile than the S&P 500 over that period. Advertisement In the 2007-09 bear market, Capital Appreciation lost 41.0%, compared with a 55.3% drop for the S&P. In the 2000-02 bear market, the fund gained 24.1%. “This is a low-risk fund, but we’re not so conservative that we can’t outperform over a market cycle,” says Giroux, 37. Just as Giroux is bulking up today on one of the market’s most hated sectors -- industrial stocks -- so he bought a bunch of the big financial stocks in the last quarter of 2008, as panicked investors were dumping them. The daredevil strategy helped Capital Appreciation beat the S&P by 6.6 percentage points in 2009. But don’t count on the fund keeping pace in bull markets. “If the market rallies 20% from here, we’re probably not going to be up 20%,” Giroux says. The bond portion of the fund is unconventional, too. Giroux owns no government bonds, which will almost certainly lose value when interest rates rise. Almost all of the debt instruments that Capital Appreciation owns are floating-rate loans. These are senior bank loans made to highly leveraged corporations. Because the interest rates on the debt reset as short-term interest rates change, the bond portion of Capital Appreciation’s holdings are insulated from rising yields. And even if a company goes under, recovery rates with these sorts of loans are high because they rank ahead of other bond holders in bankruptcies. Advertisement Giroux thinks the stock market at current levels is suggesting that the chance of a new recession is greater than 50%. In other words, he sees stock prices, relative to earnings and other measurements, getting closer to what they would reach in an ordinary recession. If there is a recession, Giroux is betting it will be much milder than the last one. “That was a catastrophe,” he says. Today, housing prices have already fallen 40% (meaning that it’s hard to see them going much lower), and consumers have made “dramatic progress” in reducing debt, he says. Giroux says the prices of the industrial stocks he’s buying already seem to reflect an economy in recession. “If that doesn’t materialize, the stocks have a 40% to 50% upside.” A favorite industrial is Ingersoll-Rand (IR), a conglomerate that relocated to Ireland to reduce its tax burden. The stock plunged 32% in the three months ending September 2. At a current price of $32.38, the stock trades for just 9 times estimated earnings for the coming 12 months and less than one times revenues. T. Rowe Price Capital Appreciation is a first-rate fund. But it’s not for everyone. In the fourth quarter of 2008, for instance, the fund lost 18.9% (compared with a decline of 21.9% for the S&P 500), thanks partly to Giroux’s premature move into bank stocks. The fund’s big loss was the price Giroux paid for his outsize 2009 returns. Advertisement But if you want a fund that keeps risks down and will sell stocks when they’re dear and buy them when they’re cheap, Capital Appreciation may be just what you’re looking for. It should lose a lot less than pure stock funds in a down market but still earn you healthy returns over the long haul. Note: Come back next week for the the third installment of a five-column series on my favorite low-risk stock funds. Or sign up for an E-mail alert to be notified of all my new columns as soon as they're available. Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.