S THE BEAR MARKET GRINDS ON, SHELLSHOCKED investors are faced with a stark choice: Stay in the safety of the sidelines and then try to time when to get back in, or find a "safe" way to stay fully invested. Many of those taking the first approach have been whipsawed by the periodic short, sharp bear market rallies. Those who stayed in the market have truly weathered an extremely trying time. It's no wonder then, that almost everyone is seeking the most bulletproof approach.

That's what was on the mind of recent questioner who asked, "What investment managers have suffered the least since September 11th?" If you could pinpoint them and their styles, perhaps you'd have a better chance of surviving the bear. We decided to take on the challenge.

The first order of business is framing the question in such a way that it can be reasonably answered. We don't have access to data for a comprehensive manager search. However, we do have better data on mutual funds, so we focused on that.

Starting at the Top

We limited our investment type to value and growth styles for large, mid and small company stock investments. We used Barra/S&P growth and value benchmarks from the Baseline database. For mutual fund-specific data we looked at the trailing one-year period since it encompassed more of the 9/11 affect than any other.

While you might not realize it given the volatility in the market, most stocks are actually in positive territory since the terrorist attacks. This is reflected in the first series of data covering the period from September 11, 2001 to the present (May 20, 2002). Returns for the indexes reviewed for this period are shown in table 1.

Next we looked at the narrower band of time from 9/11 to 12/31/01. The results, in many ways, were even more surprising: All major asset classes posted positive results as shown in Table 2. Notice that growth styles, particularly small and mid-caps, led the way.

Finally, to capture the immediate effects of the terrorist attack, we narrowed our focus even further, concentrating on the period from September 11th to September 21st. It was during this ten-day period -- a mere five actual trading days -- that stocks suffered their worst losses. The results are given in Table 3.

While large cap growth stocks held up best, their relative outperformance is marginal at best. As these results clearly demonstrate, there was no place to hide during this brief period. Yet it is also a fact (as shown in Tables 1 and 2) that every major asset class within the market has risen from these lows and has not returned to them.

Finding Funds

As may be expected from our longer-term look at asset class performance, all of the top 10 performers for this period invest in small company stocks, the majority of which have a value style.

But performance isn't the only issue. Recall that the core of our original question not only concerns return, but also risk. To capture this aspect, we re-ran our data only considering funds with below-market risk as measured by a three year standard deviation measure. That produced the results given in Table 5.

Conclusions or Delusions?

Why? First of all consider that only half the funds in Tables 4 and 5 have five-year histories; some don't even have 3-year numbers. Some of the managers have even shorter tenures. Was their recent performance the result of shrewd management or just plain luck? One in a row doesn't establish a trend.

Can we conclude that small-cap value funds are the safest place in market turmoil? No -- especially if you base your conclusion on the funds we found.

Chart 1: Small Cap Value? Corbin Small-Cap Value Fund

Source: S&P This chart shows the fund's style composition over time. The one thing that's been missing for over a year is a small-cap value component. That's kind of odd for a small-cap value fund.

Why? Consider the holdings of our number one performer, the Corbin Small-Cap Value Fund. According to S&P, as of March 30, 2002, it approximately 30% of the fund was in Large-cap growth issues with another 20% in mid-cap value. Roughly 25% was in small cap growth and there were no small cap value holdings.

In fact, as you can see from Chart 1, the fund hasn't held small cap value stocks in over a year. That, of course, includes the period before and immediately following September 11th. More importantly, if you look closely at Chart 1, you'll notice the fund actually used corporate bonds last year as a hedge against falling stocks prices.

Even more obvious is another fund on our performance list: FBR Small Cap Value A. Again according to S&P, the fund's largest holding as of April 30, 2002 was a 19.51% slug of U.S. Treasury Bonds. Treasuries rocketed immediately following the terrorist attack as investors sought their safety. Is there any wonder why this fund did so well?

Chart 2: Fixed Income Equity FBR Small Cap Value A

Source: S&P Although classified as a "Small-Cap Blend", the FBR Small Cap Value A Fund's largest holding as of the end of March was almost 20% is U.S. Treasury Bonds. What kind of equity is that?

Now there's nothing wrong with Treasury Bonds and there's certainly nothing sinister about holding them in mutual funds. They are, however, most certainly not small-cap stocks. Just because a fund does well within a certain category doesn't necessarily make it representative of that category. Fund categories and rankings are simply at the whim of various rating services. (For more on this, see The Name Doesn't Tell It All in the Archives.)

OK, funds aside, can we assume small-cap stocks are the safest havens during times of catastrophic events? Absolutely not. In fact, small-cap stocks are universally viewed as the most risky of domestic equity investments. Just take another look at Table 3: In the week immediately following September 11th, small-cap stocks took the hardest hits of all capitalizations. That's certainly not what you'd expect from a safe haven.

In reality, small-cap stocks' outperformance has little to do with one event and lots to do with many other factors. Last year, one was the fact that small cap stocks weren't as overvalued as other areas of the market. September 11th just helped set the stage for their return to favor.

Also, small cap stocks typically do well during the initial phases of an economic recovery. Last year's fourth quarter rally was a combination of patriotism and anticipation of an economic upswing. You'd expect small-caps to do well and they did.

So what can you conclude? Well try this:

• Different investment types lead the market at different points in the market cycle.
• It’s always a good idea to diversify among a variety of asset classes.
• Even catastrophic events do not change these basic investment truths.

Most importantly, all of this seems to confirm the long-held investment truth that performance is far more dependent on investment type than on investment management. In other words, you may invest with the best small (or mid or large) cap manager in the world; but chances are when small company stocks do poorly your small-cap portfolio will too.

It's also a pretty safe bet that if you invest in a diversified equity portfolio and you stick with it long-term, you’ll do fine, regardless of even catastrophic events.

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