CAN HELP MITIGATE THE EFFECTS OF A MARKET DOWNTURN
In our 3rd Quarter commentary we discussed how we can help our clients structure their portfolios to help meet current and future income needs while staying within their risk tolerance parameters. This quarter we want to focus on how fund managers work inside of our mutual funds to help mitigate the effects of a market downturn.
In October of 2008, right in the middle of one of the worst stock market declines in U. S. history, our firm was invited to participate in a conference call with a group of stock mutual fund managers representing multiple investment companies. At the end of the call we got the opportunity to ask fund managers the following question:
“Normally when stocks are down, investors move into bonds, but banks are failing and debt instruments have been falling in price almost as fast as stocks. Historically, if stocks and bonds are faltering, many investors turn to real estate as an investment alternative, but the real estate collapse is what caused the problems in the first-place. With those kinds of issues, how are you managing our mutual funds right now?”
Their answers were very telling. They all emphasized that they were buying stocks in the best companies in the world at prices they never thought they would see in their lifetimes. That’s when we realized our job was to encourage people not to sell while the market was down, because our mutual fund managers were setting us up for an opportunity to participate in an excellent recovery!
As we continued to look into what the mutual fund managers were capable of doing, it was very enlightening. Here are just a few tactics available to the fund managers:
- They have the option to build up their cash holdings through stock sales or new funds coming in. The cash holdings can range from 2% to 6% in most stock funds. This gives them quick investable funds if opportunities present themselves.
- They can avoid companies with high debt risk. These companies have more difficulty holding their value during an economic downturn.
- Many U.S. stock funds allow their managers to invest a portion of their funds internationally, so less of the holdings are subjected to problems in the U.S. Market. Some U.S. stock funds will allow as much as 10% of the holdings to be international. That can make a difference if the U.S. market falters.
- Many stock mutual fund managers will invest in more dividend paying companies. Obviously the dividends continue to be paid right through the down turn, and that lessens the negative effect of the drop in market prices.
- All stocks in a mutual fund do not drop at the same time. Some stocks drop ahead of others, giving a manager the opportunity to take some profits in stocks that are up and offset the gains by selling other stocks that are down. This allows the manager to take some profits for you inside the mutual fund while avoiding the capital gains taxes that would have occurred.
- Sometimes we use mutual funds that are called “Balanced funds”. Balanced funds normally have 60% of their holdings in stocks and 40% of their holdings in bonds. Most balanced fund managers have the ability to change that mix if they feel we are going into a stock decline. Under those circumstances, it is not unusual to see a balanced fund manager switch to 40% Stocks and 60% bonds.
Mutual fund investors should be very careful about pulling out of their investment without knowing what the manager might be doing inside the fund. They may already be making the adjustments for you.
Finally, even though past performance does not guarantee future results, it is important to remember that there has never been a downturn in the U.S. stock market that didn’t fully recover and go higher.
WE HOPE YOU HAD A WONDERFUL TIME WITH FAMILY AND FRIENDS THIS HOLIDAY SEASON,
AND WE LOOK FORWARD TO WORKING WITH YOU IN THE COMING NEW YEAR.
Sources: American Funds Marketing Support Department and Janus Funds Marketing Support Department