Mutual Funds and the Promise of 'Principal Preservation'

"Protection of principal" seems like a great investment ideal, especially in light of the trillions of dollars of questionable paper now floating around the financial world. The stock market's recent exaggerated gyrations and the "breaking of the buck" by a large money market fund further adds to the appeal of principal stability.

But investors should be aware that what some mutual funds say about protection of investor principal does not allows match up with what actually happens.

A text search of TheStreet.com Ratings' database parsing for mutual funds that include phrases such as "preservation of principal," "stability of principal" and "principal protection" in their statements of purpose produced a list of 59 funds -- excluding money market funds -- that explicitly committed themselves to hanging on to the principal amounts of their holders' investments. Of that group, 32 funds achieved positive "principal only" returns over the 12 months ended Aug. 31. Two members of the group ended with identical principal balances per share as a year earlier.

But despite their promises to hold on to the principal values of their clients' investments, 25 of the 59 funds suffered negative principal returns. Their overall total investment returns weren't necessarily all that bad, but they didn't make good on their statements to preserve their investors' principal.

The 10 funds whose per-share principal balances shriveled by more than 10% over the past year are tabulated in the adjoining table. Also included, for the sake of contrast, are the six funds that actually increased investor principal per share by more than 3% for the year.

Of the funds that lost principal, the biggest shortcoming of the Oppenheimer Global Opportunities Fund (OPGIX Quote - Cramer on OPGIX - Stock Picks) was most likely excess optimism in the inclusion of the words "preservation of principal" in its statement of purpose. A fund investing in global equities shouldn't realistically expect to avoid fluctuations in principal.

The trio of ING "target" funds on the list are of the "asset allocation" sort whose mandates permit their managers to swing from equities to fixed-income investments to conform to their readings of the investment milieu. So if perfectly managed -- which would be a first for any fund -- they would be expected to shift their ratios of equities and fixed-income investments in such a way as to avoid erosion of principal.

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