You don't have to be a shrinking violet to like low-risk stock funds. Jay Landgraf, a 27-year-old Army captain, served in Iraq and now trains troops at Fort Riley, Kan. He also competes in triathlons and has taken up mountain biking. But when it comes to his investments, Landgraf says he prefers a safe ride to a "roller coaster." Three years ago, his financial adviser, recognizing his client's risk-averse temperament, hooked him up with Jensen Portfolio. "I'm comfortable with its slow-and-steady approach," says Landgraf.
Triathletes pace themselves so they have enough energy to swim, bike and run to the end of the race. Like triathletes, the folks who run low-risk stock funds pace themselves -- by packaging a group of sturdy stocks that can beat the bears and hang with the bulls. Such funds are a good match for people who want to dip their toes into stocks but don't want to take the risks that wrecked so many dreams during the 2000Ð02 bear market.
We've found seven no-load funds, including Jensen, that are designed for the Jay Landgrafs of the world. Not all of these funds made money during the dark years, but those that didn't held their losses in check: None surrendered more than 16% during the bear market (during which Standard & Poor's 500-stock index lost a whopping 47%).
Our picks share several traits. All are run by veteran managers. They typically shun tech stocks and other sprinters that often peter out when the going gets rough. Note, too, that all our picks are essentially pure stock funds. You can always reduce risk by investing in balanced funds or other hybrids that, as a matter of policy, don't invest 100% of assets in stocks. The managers of our picks cut risk by investing in stocks they perceive to be safe.
A focus on quality
Jensen's results over the past five years may not seem impressive, but they blow away the numbers for most other funds that, like Jensen, focus on large, growing companies. Jensen lost just 14% during the last bear market; some of its peers plunged 70% or more.
Passing muster with Jensen's five-man management team isn't easy. To qualify, companies must show unusual consistency by producing a return on equity (a measure of profitability) of at least 15% in each of the past ten years. This requirement keeps the fund virtually free of technology and energy companies, which often ride boom-and-bust cycles. Instead, Jensen aims to hold "high-quality growth companies that have staying power regardless of economic conditions," says co-manager Bob Millen.
The team also favors companies that dominate the competition and generate plenty of cash. This free cash flow (profits left over after a company has covered its basic costs and invested in its growth) is like a wonder drug. It insulates a company from bad times, helps keep debt low, and is available for paying dividends and making acquisitions. Blue-chip behemoths General Electric and Procter & Gamble are currently among the fund's top holdings.
When speculative stocks lead the way, as they did in 2003, Jensen tends to lag in the large-growth category. But over the past decade, the fund scored in the top 5% of its peer group -- and it did so with almost 25% less volatility than its rivals.
Acceptable baggage
It's almost as if Jeff Auxier has people like Jay Landgraf in mind when he discusses his philosophy of investing. "The pain on the downside is so much more than the euphoria on the upside," says Auxier, who, after managing money for private clients for 24 years, launched Auxier Focus in 1999. Auxier goes to great lengths to avoid losses, including pulling money out of stocks if he can't find good deals. The fund recently held 17% of its assets in cash.
Price dictates where Auxier invests. Like Jensen, he prefers stocks of steady companies with strong cash flow. But to find such stocks at bargain prices, Auxier has to accept companies that carry some baggage. For example, he recently bought a passel of Bausch & Lomb stock after tainted contact-lens solution contributed to the outbreak of a potentially blinding fungal eye infection. Bausch & Lomb recalled the product, but not before its stock price dropped sharply.
Always on the defensive, Auxier fears that inflation is worse than current data suggest. That's why he likes Altria (the former Philip Morris) and Coca-Cola, companies that can raise prices to counter inflation because they have strong brands and loyal customers. His cautious approach has paid off. The fund lost less than 4% in the 2000Ð02 down market.
Home-state bias
It pays to invest in what you know. Or in the case of Bill Frels and his team at Mairs & Power Growth, it pays to invest in where you know. About two-thirds of the $2.5-billion fund's assets are in companies based in Minnesota, the managers' home state. By concentrating on nearby companies, such as Target and General Mills, says Frels, he and his colleagues can make frequent on-site visits and learn more about a company's culture and operations. Once Frels and his team buy, they don't often let go. The fund's turnover is an astonishingly low 5%, implying an average holding period of 20 years for each stock.
Frels and two analysts seek well-managed, steadily growing companies of all sizes. Frels, who has been with Mairs & Power since 1992 and has been the fund's co-manager since 1999, did not jump on the energy bandwagon, so recent performance is unimpressive. But the fund topped the SP 500 by an average of four percentage points per year over the past decade, and it actually gained 12% during the 2000Ð02 downturn. The fund's annual expense ratio of 0.69%, the lowest of the seven funds profiled here, is less than half the average of diversified domestic stock mutual funds.
Down but not out
Homestead Value's managers also appreciate beaten-down stocks. If a stock is hammered because of a minor earnings shortfall, or if it's in an out-of-favor industry, they're interested. For example, in the past two years managers Peter Morris, Stuart Teach and Mark Ashton have scooped up drug makers, such as Bristol-Myers Squibb and Abbott Laboratories, on the theory that investors have overreacted to the loss of patent protection for some products and the absence of new blockbuster medicines (see "Better Health for Drug Makers," Oct.). Then they wait patiently for their picks to play out. They hold stocks for about ten years on average.
The $540-million fund's long-term record is impressive. From its inception in 1990 to September 1, it returned an annualized 12%, beating the SP 500 by an average of one percentage point per year. Because of its bargain-bin bent, the fund can suffer when value stocks are out of favor, as it did in 1999, when it lost 3% in a year in which the SP gained 21%. A final note: Homestead comes with an unusually low minimum-investment requirement of $500, making it a good choice for new investors.
Buffett neighbor
Wally Weitz is not a pessimist. But when he considers a potential investment, he always focuses on the downside first, so he can "understand what could go wrong and how bad it could be." Weitz, who runs the $2.8-billion Weitz Value fund, has a lot in common with his Omaha, Neb., neighbor Warren Buffett. Like Buffett, Weitz seeks stocks that sell far below what he thinks a private investor would pay for the underlying company in its entirety. He looks for firms with strong balance sheets and plenty of free cash flow. It's fitting that Weitz's largest holding, at more than 8% of the portfolio, is Buffett's Berkshire Hathaway.
Weitz isn't afraid to deviate from his own formula. Although he, like Buffett, usually avoids tech stocks, he recently raised eyebrows by loading up on Dell. The stock, which is down about 40% over the past year, took a hit last summer when the company announced a massive laptop-battery recall. Says Weitz: "You do the unpopular thing and look dumb for some length of time, but you do it because you're confident that you have value at a discount."
Weitz's contrarian strategy sometimes leads to brief dry spells in performance, but the fund's long-term record speaks for itself. Weitz Value's 14% annualized return over the past ten years places it among the top 5% of all U.S. diversified funds. The fund lost 16% in the last downturn.
Dividend lover
For more than 20 years, Brian Rogers has churned out consistent gains at T. Rowe Price Equity Income with a diversified mix of high-yielding blue chips. Rogers hunts for stocks that trade at historically low price-earnings ratios and yield more than the average stock in the SP 500. He homes in on large, unloved firms that suffered temporary setbacks but have "the financial staying power to live through it," he says.
This approach has led Rogers to load up on unpopular drug and media stocks and to trim his energy holdings -- a move that sapped Equity Income's returns in 2005. "Selling an oil stock a year ago to buy Pfizer is not a move that has paid off in the past 12 months, but hopefully it will going forward," he says.
Rogers's affection for dividend payers has led to steady results. Over the past 20 years, the $19-billion fund lost money in only two calendar years and, all told, gained an annualized 12%. That beat the SP 500 by an average of one percentage point a year.
A different strategy: banking on the urge to merge
You've probably detected a theme in our list of low-risk funds: cheap stocks, strong businesses. Our final pick is a bird of a different feather entirely. The managers of Merger fund, Frederick Green and Bonnie Smith, have a single strategy: They buy a takeover target's stock after a deal has been announced. When that happens, the target's shares usually rise and approach the announced purchase price, but they don't make it all the way. The spread exists because of the risk that the deal might collapse or be renegotiated. The fund tries to capture the few pennies or dollars of appreciation that occur once the deal is consummated.
The trick for Green and Smith is to invest in deals that actually go through. This is important because the stock of a target company usually plummets when a deal collapses. But few managers are more adept at this kind of analysis than Green and Smith, who have practiced so-called merger arbitrage for 26 years.
Because of the unusual strategy, the fund also possesses a valuable characteristic: There is little connection between its day-to-day and year-to-year results and those of the overall stock market. That makes Merger fund a good pick to help dampen a portfolio's volatility.
The fund has performed strongly this year, gaining 8% in the first eight months of 2006. It gained 4% during the 2000Ð02 bear market and has had only one down year since its 1989 start. In that year, 2002, the appetite for deals waned and the fund fell 6%. Green says he and Smith won't abandon their strategy when mergers are scarce. In lean times, they hold more cash or close the fund to new investors. But Green predicts a robust flow of deals for at least the next year because many large public companies are flush with cash, and many private-equity firms are on the prowl for acquisitions. "I suspect the consolidation of corporate America has a long way to go," he says.
Our picks have been less volatile than the overall market and have generally lost less than Standard & Poor's 500-stock index during downturns. That makes them suitable for risk-averse investors.
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