Morningstar - Q2 2023 - 10

Dispatches
All-Weather Stock
Funds Do Exist
A small-value index
fund might be
the easiest way to
invest in one.
IVORY TOWERS
John Rekenthaler
Is there such a thing as an all-weather stock
fund? To try and answer that question,
I began by evaluating the returns of mutual funds
and exchange-traded funds during the three
bear-market years of 2022, 2008, and 2002.
Eligible candidates were diversified U.S.
equity funds that existed through that 21-year
period and invested an average of at least
85% of their assets in stocks.
Of the 953 funds that possessed the requisite
history, 550 lost less than the Morningstar
US Market Index during 2022, for a bear-market
success rate of 58% ( EXHIBIT 1 ). Of course,
because I defined success as any return higher
than negative 19.43%, the term is very much
relative. Nevertheless, among the group
that was evaluated, more equity funds than not
outdid the costless index.
Requiring the all-weather contenders to have
also beaten the index in 2008 whittled the
list to 305 funds, thereby creating a 32% success
rate. Adding the hurdle of 2002 shrank the
group to 251 funds, for a 26% success rate.
That outcome suggests persistence. If fund
performance had occurred randomly, then one
would expect roughly 50% of funds to
clear the initial barrier, 25% the first two hurdles,
and 12.5% all three. (The percentages would
be lowered by the drag of fund expenses
but raised by their cash holdings. Overall, a wash.)
As the actual totals were considerably higher,
especially for the three-period test, we can
reasonably assume that some U.S. equity funds
do tend to resist bear markets.
Dodging the Bear While Riding the Bull
Then again, managing downturns is only
half the battle. Ultimately, what matters for equity
investors are long-term gains. Conservatively
positioned funds need not keep pace with
equity rallies to justify their fees, but they must
at least stay within sight of the pack so
that their overall results are competitive. It does
shareholders no good if their funds are bearmarket
heroes but bull-market duds.
Thus, a full indicator of all-weather funds must
include their overall performance. From 2002
through 2022, the Morningstar US Market Index
gained an annualized 8.17%-which, not
entirely coincidentally, was right in line with the
8.17% return of Vanguard Total Stock Market
Index VTSMX, the world's largest mutual
fund. As shown in the final column of EXHIBIT 1 ,
among the 251 bear-market survivors, 112
funds-12% of the original population-also
surpassed that performance.
That struck me as a high percentage. Indeed,
I would wager that many veteran fund
observers, familiar with the arithmetic of active
management, might have guessed that
only 12% of funds in total outgained the stock
market over the past 21 years, never mind
doing so while also outdoing the indexes during
each of the three worst bear markets. There
appear to be many all-weather candidates.
EXHIBIT 1
All-Market Victors Only 12% of the funds lost less than the market in 2002,
2008, and 2022 and also beat it overall.
60%
58
40
Percentage of Existing U.S. Equity Funds That Beat the Index
32
26
20
12
2022
2022 and 2008
Source: Morningstar Direct, author's calculations. Data as of Dec. 31, 2022.
2022, 2008, and 2002
2002-22
Percentage That
Beat the Index Both
in Down Markets
and Overall
The surfeit, however, is a mirage. As previously
stated, losing 19.42% when an index
sheds 19.43% is " all-weather " in name only.
Although stock-fund investors should not
expect to turn a profit during market retreats,
they can justifiably hope for meaningfully
lower losses. Seventy percent seems
like a reasonable, albeit arbitrary, figure. I will
therefore define all-weather U.S. equity
funds as those that have outgained the overall
stock market over the long haul while
also experiencing less than 70% of the stock
market's decline in 2002, 2008, and 2022.
The All-Weather Champions
Adding that constraint narrows the field to
just five. Now came the surprise. I had expected
the finalists to invest in blue-chip stocks-
old-line companies that trade at modest prices
because their businesses are mature. However,
their operations are dependable and consistently
profitable. Representative industries include
10
Morningstar Q2 2023
40
Small
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Morningstar - Q2 2023

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