In This Bear Market, Be Ready to Buy

Stock funds are on sale.

And while it's possible that the prices of stocks, and thus stock mutual funds, will be slashed even further, this is a good time for long-term investors to be thinking about putting more money to work in the market.

Many investors are feeling queasy with the Dow Jones Industrial Average down 20.3% from its October closing high -- now technically in bear-market territory, as commonly defined as a 20% drop. Last week the Dow slid 0.5%, bringing its year-to-date drop to 14.9%.

But if you're saving toward a distant goal like retirement, remember that your investment today buys more shares. Despite bear markets and recessions, over time the stock market tends to rise and those extra shares become worth more.

"Volatility is a friend to long-term investors" who can use the "opportunity to buy when things are cheap," says Curtis Jensen, manager of Third Avenue Small-Cap Value Fund.

One way to take advantage of today's discounts without losing too much sleep: seek out mutual funds that have strong long-term returns along with less downside risk than their peers.

Ten Funds to Consider

To that end, Morningstar analysts recently sorted through their database for U.S.-stock funds with strong 10-year records under long-tenured managers -- as well as "below average" or "low" risk ratings as figured by the Chicago research firm. Those risk ratings are based on how often a fund has lost money compared with others in the same category.

A total of 16 funds met these and some additional criteria, including assets of at least $1 billion; of those 16, the 10 funds with the best 2008 performance rankings in their respective categories, including Mr. Jensen's fund, are shown here.

Focusing on a fund's long-term performance allows investors to look past recent market volatility for a better picture of overall fund performance, including how "funds performed through various market cycles," says Morningstar analyst Karin Anderson.

Over the past decade, the 16 funds identified by Morningstar have delivered returns equivalent to 6.91% a year, versus just 2.88% a year for the Standard & Poor's 500-stock index, the most widely used benchmark for U.S.-stock funds.

But investing even in proven, less-volatile stock funds doesn't mean avoiding losses. Indeed, none of the 16 funds showed a positive return from the Dow's all-time high on Oct. 9 through midyear. Over that period, 14 of the funds had smaller declines than the Dow, and 13 had smaller drops than the S&P 500.

Long-Term Perspective

A number of the funds on Morningstar's list aim to hold shares of solid businesses for years at a time. For instance, Baron Growth Fund seeks well-managed small businesses with the potential to double in size every five years, while doubling the value of the fund's investment, says manager Ron Baron. "We look for companies that are going to grow in a long period of time, no matter what happens in the stock market."

While the companies may be growing, however, those share prices on average haven't grown in recent months: Baron Growth was down 14.18% from the market high through midyear.

Mr. Baron figures even the fund's worst-performing holdings this quarter, recreation and resort companies including Wynn Resorts and Ameristar Casinos, will eventually "see a comeback." People are trimming their spending now, but in time "everyone wants to go on vacation and will just work harder to get there," he says.

Mr. Jensen's Third Avenue Small-Cap Value has the best 10-year record among the 10 funds on our list, and it has also declined the least since the market peak. It ranks in the top 10% of Morningstar's "small value" fund category so far this year and over the past 12 months.

Mr. Jensen aims to invest in cheaply priced stocks of companies with strong balance sheets. The fund has benefited from significant holdings in the strong-performing energy sector while avoiding struggling financial companies and home builders.

Taking a different tack, Meridian Growth, run by Rick Aster, tends to avoid cyclical stocks like energy and industrials. "Meridian bets on consumer staples with a patient approach that has been holding up well," Ms. Anderson of Morningstar says. One recent top holding: dental-products supplier Dentsply International.

Stung by Financials

Some funds that favor stable dividend-paying stocks have been stung recently by losses on financial shares, traditionally a core holding of such funds.

For instance, American Century Equity Income Fund sold Citigroup and Freddie Mac at a loss in the second half of last year, co-manager Phil Davidson says. The fund declined 14.5% from the Dow's peak through midyear.

Still, the fund ranks in the top 20% of Morningstar's "large value" category this year and over the past 12 months. "It would be almost impossible not to be down, but we're keeping our record going on a relative basis and hoping for a smoother ride," Mr. Davidson says.

Source : http://online.wsj.com