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Mutual funds

3 stock funds to reduce risk as fiscal cliff looms

Investors are anxious. The Dow Jones industrial average had its steepest two-day sell-off of the year on Wednesday and Thursday. With the election behind, the so-called fiscal cliff came into focus.

It’s such a pressing concern that it’s worthwhile to consider the ‘‘what-ifs.’’ Are you comfortable with possible losses if Congress and President Obama fail to agree on deficit reduction by the end of the year?

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If you’re not, it could be an opportune time to assess your portfolio and consider whether to modestly reduce your risk level, at least until a resolution is in sight. One option: Consider stock funds that succeeded in limiting losses when the market fell sharply in recent years, while also performing well over the long haul.

The fragile economic recovery could be derailed if leaders can’t forge some sort of agreement or interim step by Jan. 1 to better align revenue with spending. New Year’s Eve could turn somber as Americans ponder an end to Bush-era tax cuts that would expire in the morning. What’s more, automatic spending reductions would affect everything from domestic programs to defense.

Fresh off Tuesday’s election, Obama and Republican House Speaker John Boehner were conciliatory. Each pledged to work toward a bipartisan compromise. Yet the failure of past efforts doesn’t inspire confidence.

‘‘There seems to be a fairly good chance that it won’t go very smoothly, and things won’t get resolved until the last minute,’’ says Hal Ratner, an investment researcher with Morningstar Inc.

The Dow dropped 313 points on Wednesday, then another 121 on Thursday. A key reason: Investors fretted about the deficit negotiations because the election results could keep in place the same congressional leaders and president who had so much trouble coming together before.

There’s little reason for younger investors to worry, as they should have plenty of time to make up for any losses. There’s greater cause for concern if you’re expecting to retire soon, or if you’re already relying on your invested savings.

In either case, you’re likely to want to stay in stocks to some degree because they offer greater earnings potential than bonds or cash investments. But be aware that you can do so while minimizing risks.

Below are three stock funds that have limited investors’ losses in past downturns, and could again prove their worth whether markets become more volatile or not.

Each invests primarily in large US companies, the types of stocks that typically anchor a well-diversified portfolio. They’re categorized as blend funds, investing in a mix of low-priced value stocks along with growth stocks offering greater potential for long-term appreciation. The funds have 5-star records from Morningstar because of strong past performance. Morningstar analysts currently give each a top-rung gold medal rating, based on their assessments of each fund’s future prospects.

In terms of the risks taken to achieve their investment returns, each is rated ‘‘Low’’ by Morningstar, the lowest on a five-level scale. These ratings assess a fund’s risks versus peers by a number of measures. Among them are the amounts of gains the fund was able to capture when stocks were rising, and the extent of losses in periods when the market was falling. These are known as a fund’s upside and downside capture ratios. They’re among the fund volatility measures found on Morningstar.com by clicking on a fund’s ‘‘risk & ratings statistics’’ tab.

Each of the funds charges fees of 1 percent or less. That’s relatively modest given that these are actively managed funds that seek to beat the market, rather than index funds seeking merely to match it.

Each requires a minimum initial investment of $5,000 or less, so they’re accessible to many individual investors.

The three, listed in order of their 10-year returns:

FMI large cap. This fund’s 5- and 10-year returns rank within the top 5 percent of its large-cap blend peers. It was a standout performer during the financial crisis, losing a relatively small 27 percent in 2008 while the S&P 500 plunged 37 percent. The team that manages it looks for businesses with the financial strength to hold up well even if the economy slows down. FMI Large Cap recently owned a relatively compact portfolio of 27 stocks, led by 3M Co. and Berkshire Hathaway, Warren Buffett’s company.

Vanguard Dividend Growth. This fund’s 5-year return ranks in the top 3 percent among its peers, and its 2008 loss was a relatively small 26 percent. It’s one of the standout managed funds at Vanguard, best known for index funds. With an expense ratio of just 0.31 percent, it’s among the lowest-cost managed funds. The emphasis in the portfolio of around 50 stocks is dividend-payers. Recent top holdings include PepsiCo, Johnson & Johnson, and Occidental Petroleum.

Sequoia Fund. This fund’s 3- and 5-year records rank within the top 2 percent of its peers. Managers Robert Goldfarb and David Poppe typically hold just 10 to 25 favored stocks and stick with them for years. Recent top holdings include Valeant Pharmaceuticals and TJX Cos., owner of the T.J. Maxx and Marshalls retail chains. The fund recently had nearly 18 percent of its portfolio in cash, which could provide a cushion if the market drops. In 2008, Sequoia lost a relatively modest 27 percent.

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