Conventional wisdom offers two bits of advice for investors seeking to navigate a treacherous bear market. The first is to maintain a flexible approach in order to raise cash or focus on the best-positioned stocks when markets turn hostile. The second is to emphasize relatively inexpensive "value" stocks to avoid the sharp losses often exhibited by fast-growing firms that appear especially vulnerable in market downturns.

In two articles appearing on the front page of the quarterly mutual fund analysis section in last week's Wall Street Journal, a reporter examined these assertions and found that, for many investors, such strategies only served to compound the anxiety associated with this year's plunging stock market by losing money even faster.

According to the article (citing Morningstar data), 61% of US large cap mutual funds trailed the S&P 500 Index® for the year ended September 30, 2008. Despite a slump in the index of 23.7% over this period, there were still money-making opportunities for an alert investor to capitalize on: Anheuser-Busch shares rose 29.8%, Wal-Mart Stores jumped 37.2%, and, oddly enough, shares of luxury homebuilder Toll Brothers were up 26.2%. But it appears most active fund managers wound up in the wrong stocks at the wrong time. Results among other sectors were even worse, with nine out of ten actively managed funds underperforming the S&P MidCap 400® Index.

A related article questioned the popular notion that value stocks offer a defensive strategy well-suited for treacherous markets. The reporter pointed out that professor Eugene Fama (a Dimensional director and consultant) disputed the idea that value investing was a safer approach ("not true") and observed that the average large cap value fund was down over 24% for the year ended September 30, 2008. These results are a "wake-up call" for fund investors, the author said. "Value investing is risky just like any other stock strategy, and sometimes even riskier."

Making matters worse, a number of prominent fund managers who had received accolades for avoiding the bust in technology shares in 2000-2002 lost even more heavily than the average value fund as a result of concentrated positions in "cheap" stocks such as Fannie Mae or Freddie Mac that became much cheaper as the housing market collapsed.

One industry veteran cited in the article appears to believe that the dismal performance of many notable mangers this year may have repercussions that last for years: "The very likely takeaway may be that it's too hard to pick managers," said Morningstar Managing Director Don Phillips—"these great mythic figures don't walk the earth."

Lauricella, Tom. "A Tough Bear Market Knocks 'Value' Managers Off Pedestals." Wall Street Journal, October 2, 2008. Lauricella, Tom. "In a Down Market, Many Fund Managers Were Down Even More." Wall Street Journal, October 2, 2008. Standard & Poor's. Stock Guide, October 2007. Wall Street Journal, "Biggest 1500 Stocks," October 1, 2008.

Bear Markets And Active Managers