T. Rowe Price Capital Appreciation typically lags in bull markets, but it excels in bear markets. By Steven Goldberg, Contributing Columnist May 12, 2010 After the wild gyrations of the past three years, most investors could care less about beating the stock market. What they want is to earn decent returns -- with a lot less volatility than the overall market. The misnamed T. Rowe Price Capital Appreciation Fund (symbol PRWCX) is tailor-made for risk-averse investors. With only about 65% of its assets in stocks, it’s not likely to finish ahead of the indexes in sizzling bull markets. The fund’s return of 33% last year -- 6.5 percentage points ahead of Standard & Poor’s 500-stock index -- is just as much a testament to how cheap many stocks were as it is to manager David Giroux’s skills. However, its 2008 loss of 27% -- ten points fewer than the S&P 500’s decline -- better represents the performance longtime shareholders have come to expect and appreciate. Giroux says his fund is for conservative investors: “If the market is up 20%, they’re not going to be concerned if the fund is up 15%. Our goal is to find securities with limited downside risk and reasonable upside potential.” The fund has succeeded in meeting that goal. Over the past five years through May 10, it returned an annualized 5.9% -- an average of 3.9 percentage points more per year than the S&P. The fund’s 2.1% yield and 0.74% expense ratio are also pluses. Advertisement Over the past three years, Capital Appreciation was 23% less volatile than the average stock fund, making it easier for the typical investor to ride through the ups and, especially, the downs. Even during the vicious 2008 downturn, Capital Appreciation investors were unlikely to bail out, reports Morningstar. That year the average dollar invested in the fund lost just six-tenths of a percentage point more than the fund did. With volatile stock funds, Morningstar has found that poor timing—typically the result of emotional reactions to strong or horrendous performance—often leads investors to trail fund returns by two or three percentage points per year. What T. Rowe Capital Appreciation likes now. A year ago, Giroux owned many cheap stocks among lower-quality companies, such as banks. “When the market is cheap, we’re aggressive,” says Giroux. Today, it’s a different story. Most stocks look fairly valued, Giroux says. Consequently, he has moved the portfolio into more-typical fare: Stable companies with competitive advantages that have steady earnings growth and often pay dividends -- yet trade at below-market prices relative to earnings and other measures. Don’t look for glamour stocks such as Apple and Google here. They’re great companies and, perhaps, terrific investments. But a lot of good news is already reflected in their prices, says Giroux. Instead, he owns such steady-eddies as ExxonMobil (XOM), General Mills (GIS), International Business Machines (IBM), PepsiCo (PEP) and Pfizer (PFE). These are solid blue chips that are likely to hold up relatively well if the market slides. Advertisement Capital Appreciation usually looks like a balanced fund, with about one-third of its assets in bonds and convertible securities. But with yields low, Giroux finds little to like in the bond market. Because he sees a danger of bond prices falling as interest rates rise, he holds about 13% of the fund in cash. It also owns some short-maturity bonds as well as floating-rate loans (loans made by banks to low-quality companies with rates that adjust regularly). The fund has 9% of assets in convertible securities -- hybrids that exhibit some traits of bonds and some of stocks. Giroux used to own more convertibles, but the market for them has shrunk because of an accounting-rule change that has made issuing convertibles less attractive to companies. Lately, Giroux began selling covered call options on stocks that are close to his target prices. By selling calls, Giroux gives the option’s buyer the right to buy a stock at a pre-determined price by a pre-determined date. “We’re not giving anything up because we’d be selling at the call price anyway,” he says. He typically sells calls on 15% to 20% of the fund’s stock holdings. Giroux, 34, has been managing the fund only since mid 2006. At most fund companies, Giroux’s youth would be a big negative. But Giroux has worked at Price for 12 years and is assisted by the firm’s first-rate team of analysts. Price is an unusually well-managed fund company. I don’t think it would have put Giroux in charge unless he was up to the job. So far, he’s more than measured up. Steven T. Goldberg (bio) is an investment adviser.