"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
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.
But "premature articulation of investment intent" seems to be the malady suffered by the three ING funds. Their oaths to "preserve principal" are best taken more literally 17 to 37 years hence when their holders -- then presumably in retirement -- will be in need of steady income from stable bases or principal.
With decades to go until their targets, the present holdings of the ING funds would be expected to include growth vehicles that would be expected drive fund principal values per shares to lower from time to time.
Similarly, two balanced funds on the losers-of-principal list should have known better than to cross their fingers and include intentions to principal preservation in their statements of objective.
Balanced funds, by definition, tend to maintain relatively constant ratios of equities and fixed-income investments. Even with blue-chip stocks like
among its major stock positions, the
Oppenheimer Balanced Fund
would seem overly optimistic in not expecting some fluctuation in principal per share.
Plumb Balanced Fund
, with major equity holdings that include
Johnson & Johnson
, is unrealistic in not expecting its fixed-income holdings to immunize it from periodic erosion of principal.
The big lesson in this to look beyond a fund's statement of objective. Common sense should dictate that the six funds in the top section might be appropriate for some investors, but not necessarily for those who couldn't tolerate principal values per share that would be expected to move downward on occasion.
On the roster of funds that enhanced their principal values per share by more than 3%, each of the six funds have been achieving returns well in excess of money market rates while building their share principal balances.
The two Fidelity fixed-income funds and the Prudential offering in the "accumulators of principal" section gained value by hugging the short to intermediate end of the maturity spectrum. Having a presence in government issues provided additional stability for the pair of Fidelity funds, while a portfolio of super-secure Treasury securities provided principal appreciation for the ISI fund.
For the pair of institutional Delaware global fixed income funds, appreciation of foreign currencies relative to the U.S. dollar help boost the principal values per share.
Richard Widows is a senior financial analyst for TheStreet.com Ratings. Prior to joining TheStreet.com, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.