NEW YORK ( TheStreet) -- As markets sank in 2008, some top funds played defense. The portfolio managers held cash and avoided shaky stocks. The moves worked, enabling the funds to outdo competitors during the turmoil.

This year some of the cautious performers have been lagging. Worried about the outlook for the economy, the managers are still holding some cash and sticking with rock-solid stocks. That has held back returns as markets have climbed.

But shareholders of the conservative funds should not be discouraged. The cautious approach can help to stabilize portfolios. And by avoiding big losses in downturns, the conservative funds can deliver solid long-term returns.

Consider Forester Value ( FVALX), which has 18% of assets in cash. This year, the fund has returned 2.3%, lagging its large value competitors by 3 percentage points.

But Forester's long-term record remains sterling. During the past five years, the fund has returned 3.6% annually, outdoing 96% of peers.

Besides holding cash in uncertain markets, portfolio manager Tom Forester limits risk by buying puts, options that increase in value as stocks fall. The strategy worked brilliantly in 2002. In a year when the S&P lost 22.2%, Forester returned 5.7%. In 2008, the fund won attention by being the only diversified domestic equity fund to stay in the black.

As stocks reached bargain levels in the first quarter of 2009, Forester used all his cash to buy stocks. But this year, he has grown wary again, concerned about European debt problems and U.S. budget deficits. "We are being a bit cautious because there is a lot of risk in the world right now," he says.

Forester aims to find discounted companies that have the ability to improve sales and earnings. To find promising shares, he starts by combing through the ranks of stocks with the lowest price-to-earnings ratios. If none of those have positive outlooks, the portfolio manager will take more expensive names. The idea is to own the cheapest stocks available with solid prospects.

He recently bought Kroger ( KR), the supermarket chain. The stock has a forward P/E ratio of 11. That is a cheap price for a company that can grow in difficult markets, says Forester.

He also likes Microsoft ( MSFT), which sells for a forward P/E ratio of 9. Forester says that the software giant is hitting on all cylinders. The Windows 7 operating system is achieving wide acceptance, while the Bing search engine is gaining market share.

Another fund that excels in downturns is Osterweis ( OSTFX), which has returned 3.0% annually during the past five years, outdoing the S&P 500 by more than 2 percentage points. This year, the fund has returned 7.2%, trailing the S&P slightly.

During the worst days of the credit crisis in 2008, portfolio manager John Osterweis shifted 50% of assets to cash. Now that conditions appear less treacherous, the cash stake has declined to 18% of assets. "Our view is that if we can avoid big losses in downturns, then we don't have to be heroes in up markets," says Osterweis.

A dedicated value hunter, Osterweis looks for companies that seem likely to rebound after suffering periods of disappointing results. A favorite holding is American Water Works ( AWK), a utility that yields 3.6%.

Osterweis says that the utility languished during the period when it was owned by a German company. But now American Water Works is again an independent public company, and the business seems likely to increase earnings by making acquisitions and winning rate increases from regulators.

Osterweis also likes Unilever ( UN), the consumer products giant. The company had been a chronic underperformer, but a new chief executive has been cutting costs and boosting margins. "Investors considered the company to be poorly run, but now the perception is improving," says Osterweis.

Another low-risk fund is First Eagle US Value ( FEVAX), which has returned 5.0% annually during the past five years, outdoing 97% of large blend competitors.

For safety, the fund often holds cash and gold. A big cash stake helped the fund outdo the S&P 500 by 14 percentage points in 2008. This year the fund has 17% of assets in cash and trails the benchmark by a hair.

To avoid trouble, First Eagle buys rock-solid companies selling at discounts. Holdings include Home Depot ( HD) and American Express ( AXP), blue-chips that slipped when consumer sales sank during the recession.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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