Lipper Research Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN - Safe/Safer Funds

A. Sure. But I think investors should start with a combination strategy/psychology question first...

Q. What's that?

A. Well, people should step back and assess why they may want to be changing their portfolios: is it out of a real belief that we've started a bear market and will go a lot lower, or is it just from gut-level fear from what has happened in the past few weeks? If you believe the bull market or at least a sideways market is still intact, selling now may get you out at a low price rather than a high one.

Q. Good point. But periodic check-ups on asset allocation are in order anyway, right?

A. Definitely. And when those are done regularly, they tend to tell people to shave off some of what has done very well, before it drops, since it will reach above-desired percentages of total portfolio value.

Q. Okay. So, with that said, what are some of the safe or safer funds types that might let their holders sleep a little better?

A. Well, I think we really can talk about it on three levels.

Q. First?

A. Asset allocation. Has your portfolio done so well that your bond/stock/cash balance is out of kilter? Certainly, many investors saw that happen in late-1999 and early-2000 and wish they had paid attention.

Q. What is the yardstick to use?

A. Everyone's risk tolerance--and need to take risk to build capital--will be a little different, but as a general average I'd use the Rule of 110: subtract your age from 110 and the result should be what you have in equity: stocks and stock funds. Any changes you make should aim to bring you closer to that number.

Q. Okay, and what is the second level?

A. This is a bit of a subtle point, but some investors may have selected funds based on performance. And guess what: in up-markets the funds taking the biggest risks rise to the top of their list by category. So, holders should usually also expect above-average volatility on the downside from such funds. It comes with the territory because of the way the portfolio manager manages.

Q. Doesn't Lipper have a rating in your "Lipper Leaders" system for that?

A. Yes, actually two that would help. "Consistency" tells you about the general volatility of a fund against its peers, and "Preservation" rates how well a fund has done in down periods against its peers. These measures can be quite revealing and helpful for understanding a fund's personality.

Q. Okay, but what about the actual investment objectives of funds: which types are somewhat safer than others?

A. Clearly, bond funds tend to be safer than stock funds, but make no mistake: bond funds can move a lot! The ETF called "TLT," which holds long-term U.S. Treasury bonds, in the past 12 months has fallen from over 96 to under 83 a couple of weeks back. That's a drop of more than 13%.

Q. So, would it be better to hold short-term bond funds?

A. As a general matter of risk (meaning uncertainty of returns), yes, and especially if you expect inflation and interest rates to keep rising--or maybe a laddered bond fund.

Q. But you'll get lower income...

A. A little bit, but with the flat yield curve there's not much difference right now. A good way to get decent yield and not have much principal risk is to own TIPS bonds or TIPS funds. Their total yield including indexed principal is a little more than from straight Treasury bonds. But they are not very tax-efficient, so be careful where you own them.

Q. And among stock funds, what are the less-risky types?

A. Starting off by saying that nothing in the stock market can truly be "safe," I'd call these types of funds less risky than most others:

• Balanced funds (which have at least 30% and sometimes as much as 70% bonds in them)
• Domestic equity funds, as contrasted with world equity and especially emerging markets funds, which are very volatile
• Large-cap, as contrasted with small-cap; bigger-company stocks just tend to be less volatile
• Value style, as contrasted with growth style; stocks with lower P/Es and higher dividend yields hold up better in down-markets

Q. What about sector funds? Are any of them fairly safe?

A. Well, a sector fund, like a country or region fund, is by definition concentrated. So, you are making a very specific bet on its area doing well.

That being said, I would say funds with higher yields, like real estate and utility funds, are more likely to have price cushions than, say, technology or biotech or natural resources funds.

Q. Don't you worry about yield-type sector funds when people can buy one-year CDs yielding about 5.2%?

A. Yes, I do have some concerns there. But good real estate and utility funds will give you growing income over time. And if the Fed overtightens and we get a flatter economy, long rates will stop rising. It's interesting that real estate funds, as of last Friday's tally, were the top performers YTD domestically--up 9.5%--and utility funds were ahead 4.9%, while the S&P was up only 1.4%. Big dividends are nice cushions. I guess if the whole stock market is going to dive because of rising rates, stocks and funds with fat dividends will hold up best.

Q. Are there any other sectors that represent below-average risk, do you think?

A. Traditionally, consumer staples and healthcare funds own the kinds of stocks that hold up relatively well in down markets. People buy those goods and services in any kind of economy, so they are thought of as fairly "recession-resistant." For the contrarians health/biotech funds have lagged the average equity fund for each year starting 2002, so you could say they are not exactly owning extremely pricey stocks!

Q. But in a health and bio fund, don't you have the volatility of the biotech stocks it holds?

A. Definitely! That is one reason people are using ETFs more and more, since you can often choose very-specific indices rather than broad ones if you prefer. And a family like Fidelity (not a specific recommendation) has more than 40 industry funds that in many cases are fairly narrowly defined. Check out the Web site ETFconnect.com for a long list of sector/industry ETF ideas.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).