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Hardly anyone predicted the size and scope of the recent market meltdown. At the depths of the crisis, which started in 2007 and continues today, there was almost no place for investors to hide.
Still, some investors protected their portfolios far better than others at a time when the concept of investment risk seemed to take on a new dimension. BusinessWeek talked to these investing pros in search of their secrets to success.
The bottom line: There was no simple solution. Successful investing strategies in the past couple of years represented a wide range of philosophies and investment choices. Yet nearly all these top investors, relying on years of experience, sought out only high-quality investments, and many of them were aware of financial and housing difficulties early.
Which pros managed to sidestep the worst of the market mayhem? What were their strategies? Here's a look:
Ann Benjamin and Thomas O'Reilly, Neuberger Berman High Income Bond Fund (LBHBX)
For Benjamin and O'Reilly, investing is about keeping an eye on the big picture. In 2005, their Neuberger Berman High Income Bond Fund pulled out of bonds exposed to the overheated housing market.
They didn't predict a big housing crash, Benjamin says, but "we thought there was significant oversupply being built in the market."
In 2007 they lightened exposure to more cyclical industries—the sort that would be hurt by the coming recession. "You have to be ahead of the curve," O'Reilly says. "You can't sell on the news." Rather, you need to anticipate the news.
Last year was tough on high-income bond funds, but the Neuberger Berman High Income Bond Fund fell 19% in 2008, beating its Morningstar (MORN) category by 22.5 percentage points. The fund is rated five stars by Morningstar.
Benjamin and O'Reilly are looking ahead, trying to predict the market and the economy's next moves. Fearing the economy could keep dragging longer than predicted, they carefully examine companies to make sure their investments "make it through the cycle," Benjamin says.
Rich Gates, TFS Market Neutral (TFSMX)
By contrast, Rich Gates doesn't shift approaches depending on his predictions of the future. His TFS Market Neutral fund has used the same quantitative strategy since it was started five years ago. It's an approach similar to the hedge fund strategies TFS has run since 2001.
This U.S. equity fund fell just 7.3% in 2008, beating the broad Standard & Poor's 500, which dropped 37.2%, and doing 7 percentage points better than its Morningstar category.
The fund protects assets not just by buying stocks, or going "long," so the fund benefits when prices rise. It also shorts other stocks, by borrowing shares and selling them so the fund benefits when prices fall. The fund stays three-fifths in long positions and two-fifths short.
The fund's computers automatically rank equities according to consistent (and proprietary) criteria, seeking out stocks to buy and short for a few days or up to a month. The shorting strategy limited losses in a tough year, but TFS has also chosen the right stocks to outperform the market in good years like 2006. "It's definitely harder in an up market than a down market," Gates says.
Eric Cinnamond, Intrepid Small Cap Fund (ICMAX)
For Cinnamond, investing starts with close examination of individual companies. "We're just focusing business by business," Cinnamond says. The Intrepid Small Cap Fund buys a stock if it is a "good business"—with a strong balance sheet and consistent cash flow—and if it's priced 20% less than Cinnamond thinks it's worth.
In 2007, when stocks peaked, Cinnamond says nothing was meeting his criteria. "I couldn't find anything," he says. He also avoided financial stocks, believing the rapid increase in mortgage debt was a bubble that would burst.
With much of the market overvalued, Cinnamond had much of his portfolio in cash—perhaps the safest place to be—as the market slid during 2008. At the start of 2008, cash was almost 40% of his portfolio.
In the past 12 months, the fund, rated five stars by Morningstar, has lost just 2.5%, 36 percentage points better than the S&P 500. In early March, when stocks hit their bear market lows, the fund had almost no cash at all, because it was fully invested in equities.
"Now we're able to buy some great companies at deep discounts," he says. "It's the perfect scenario."
Roger Vogel, Silvercrest Asset Management
Vogel also focuses on individual companies, and especially their management teams.
"We get our feel for what's happening in the economy from our companies," Vogel says. Like most "value" investors, he looks for companies trading at a discount. But his fund is "quality-oriented." Sticking with financially secure firms has helped during the credit crisis.
As the crisis unfolds and recession continues, "the strong will emerge stronger and the weak will go away," Vogel says.
He judges firms not just by their numbers but also by their executives. More than two decades of experience help in evaluating management presentations, he says. "If you're an experienced investor, you tend to come out of those with a different mindset," he says.
Silvercrest's small-cap value portfolio—managed for the firm's private clients—is down 6.7% in the past three years, compared to a 17.5% decline for the Russell 2000 Value index.
Jim Moffett, UMB Scout International Fund (UMBWX)
Moffett also focuses on quality, though he does so in international stocks.
Quality "means starting with a balance sheet with not too much debt," Moffett says. His UMB Scout International Fund has traditionally avoided financial stocks because of their reliance on debt and their lack of transparency, he says.
He also avoids too much risk by, for example, staying out of China and Russia, which saw huge market declines. "That's where the reward is, but that's also where the risk is," he says. "We thought the risk was higher than people appreciated."
His fund picks stocks for the long term only after careful vetting, he says. There's "not a lot of razzle-dazzle," he says. "Just stick to the basics."
Moffett's fund, rated five stars by Morningstar, fell 38% in 2008, a disastrous year for overseas stocks, but it beat its benchmark and Morningstar category by more than 5 percentage points.
Emmanuel Ferreira, Oppenheimer Quest Opportunity Value Fund (QVOPX)
For Ferreira, the key to investing is flexibility. The Oppenheimer Quest Opportunity Value Fund can buy or short almost any asset, from bonds to stocks to commodities.
"It's really a mutual fund format where we are allowed to have hedge fund flexibility," he says, adding, "When you have a fund that's flexible, you can take advantage of a lot more opportunities."
Ferreira spotted problems in housing and mortgage debt early. In 2005 and 2006, the fund started shorting—or betting against—subprime mortgage securities. By the time the fund had unwound those bets, it had earned about $200 million—"30 times the money we put at risk."
By the end of 2006, the worry was "too much excess in the financial system and the global economy," Ferreira says. The fund's response was to shift assets into cash.
The fund, rated five stars by Morningstar, is down 17% in the past 12 months.
Michael Cuggino, Permanent Portfolio (PRPFX)
Expect no bold predictions from Cuggino, who says his fund is "based on the premise that the future is unpredictable and investors should prepare themselves for a variety of a different outcomes."
People—even and especially portfolio managers—are bad at predicting the future, he says. So, the Permanent Portfolio is diversified in a wide array of asset classes, a classic risk-management strategy. Gold is 20% of the portfolio, silver 5%, and Swiss-denominated assets are 10%. Equities based on natural resources are 15%, while U.S. growth stocks are 15%, and 35% of the fund sits in U.S. and corporate bonds.
The fund might underperform in a fast-rising bull market for stocks, but there's stability and protection in its broad strategy.
There's little room for managers to make a big bet on one lucrative strategy, but on the flip side, the chance for big losses is reduced. The approach has worked: The five-star Morningstar fund lost just 8.4% in 2008.
Steverman is a reporter for BusinessWeek's Investing channel.