Course 204: Looking at Historical Risk, Part 2
Bear-Market Rankings
In this course
1 Introduction
2 Morningstar Risk
3 Bear-Market Rankings

Bear-market rankings compare how funds have held up during market downturns over the past five years. This measure is unlike the others presented thus far, because it examines performance only during the times in which investors may face the largest potential for losses—during downturns, or corrections, in the market.

A bear market is officially defined as a sustained market correction, but for the purpose of these rankings, Morningstar identifies "bear-market months" that have occurred in the past five years. For stock funds, we consider any month in which the S&P 500 Index lost more than 3% to be a bear-market month. For bond funds, we count any month in which the Barclays Aggregate Bond Index lost more than 1%.

To generate our current bear-market rankings, we simply total each fund's performance during bear-market months over the past five years and separate them into percentiles. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1. These scores can help predict which funds will hold up well should the market undergo another correction.

Bear-market rankings have two major drawbacks. First, these measures let you know how a fund performed only during certain time periods. Although it's helpful to know how your fund performed during these market downturns, the fund could certainly lose money—lots of it—during a market upturn, too. Gold funds, for instance, often earn decent bear-market ranks, but they lose money at other times and are not considered low-risk investments.

The second drawback to bear-market rankings is that not all bear markets are the same. The next market correction may be caused by different economic forces than those that led to the previous one. Hence, funds that held up well in one bear market may not do so well in the next. Conversely, funds that were pummeled the last time around might shine in the next bear market.

All of the risk measurements we've discussed are based solely on past performance. By definition, they fail to account for any future risks a fund might harbor. For example, a fund that used to own mostly low-key large-company stocks may now be heavily invested in smaller companies, and therefore it may be taking on more risk than its historical measures show. Given this limitation, remember that statistical risk measures are a good way to begin understanding a fund's risk, but they're not guarantees of safety.

Next: The Quiz >>


Search
Print Lesson |Feedback
Del.icio.us Del.icio.us | Digg! digg it
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.
Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy.
If you have questions or comments please contact Morningstar.