For Bear Market Protection
Advisers Should Consider These Mutual Funds

inancial advisers have a duty to protect an investment portfolio against losses. Despite that duty, many advisers blame their customers' investment losses on the bear market, and then predict that the markets will "come back", thereby making the customers' accounts profitable. Bear markets do come and go. But competent financial advisers must do more. They must plan for bear markets, and must take action to protect their customers' investment portfolios against losses.

One prudent course of action is diversification. We previously discussed why it is prudent for investors to diversify among various classes of investments, such as bonds, real estate based and precious metals based investments, as well as money market funds.

However, despite these considerations, some investors may wish to remain fully invested in stocks. This article describes one analysis that can be performed to determine how best to invest in stocks through mutual funds during a bear market. Although further research is recommended, the analysis highlights how simple it is for financial advisers to plan and take action on behalf of their customers.

Utilizing Morningstar's Principia Pro Plus, we performed a search of all mutual funds that: 1) invest predominantly in equities; and 2) have the top 2% "Bear Market Rank". Morningstar defines Bear Market Rank as a measure of how a fund has performed during bear markets on an historical basis. Morningstar defines a bear market for stocks as all months in the past five years that the S&P 500 lost more than 3%. To arrive at the Bear Market Rank, Morningstar adds a mutual fund's performance during each bear market month to reach a total bear market return. Based upon these returns, each mutual fund is assigned a percentile ranking.

Our search uncovered four mutual funds in the top two percentile in Bear Market Rank. They are the Clipper Fund, Vontobel U.S. Value Fund, the Copley Fund and the Primary Income Fund. If you believe that one of these funds may be appropriate for your portfolio, you should consult your financial adviser to determine if that investment is suitable for you given your risk tolerance, investment objectives and financial capability.

First, the Clipper Fund primarily invests in undervalued equities. It is overweighted (as of December 31, 2001) in financial companies. Further, it earns a very high alpha (which measures the value that the fund's manager adds in terms of his actual returns in relation to the expected returns and the risk that he assumes). This no-load fund is managed by Pacific Financial Research, earns a "5 Star" rating by Morningstar and currently has over $2 billion in assets.

Second, the Vontobel U.S. Value Fund is related to Vontobel Holdings AG, a Swiss banking group with subsidiaries managing assets globally. This fund tends to be extremely overweighted in financials. Like the Clipper Fund, Morningstar gives this no-load fund a 5 Star rating. However, Morningstar cautions that the fund probably is too concentrated in financial stocks to be a core holding for most investors and, instead, recommends it as a "great diversifier" and a "well-run value fund".

The third mutual fund is the Copley Fund. This fund receives a 3 Star rating by Morningstar. It invests in large capitalization value stocks. In terms of alpha, for the risk that the fund assumes, one would expect its returns to be better than what they have been. This fund is overweighted in utilities, by a factor of 3 to 1 compared to the S&P 500.

The fourth and final mutual fund is Primary Income, which is part of the Primary Trend Family of Funds. This fund invests broadly in all of the major sectors. This no load fund receives a 3 Star rating by Morningstar. Interestingly, this fund has attracted little notoriety, as it has only about $4 million in assets.

This analysis demonstrates that data exists for financial advisers to do their homework to protect customers' investment portfolios in a bear market. Further research obviously is required. But beware of the financial adviser who does not even bother to do the homework. That adviser, not the bear market, will be to blame for losses in the portfolio.

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James J. Eccleston is a securities attorney, representing investors as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He is a past co-chair of the Chicago Bar Association's Securities Law Committee, a past chair of its Financial and Investment Services Committee, a registered investment advisor and a licensed securities principal of the National Association of Securities Dealers (NASD). He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat & Filipowski and can be reached at 312-621-4400.