Financial Funds That Didn't Crash and Burn

FBR Small Cap Financial(FBRSX Quote), Burnham Financial Industries(BURFX Quote) and Mutual Financial Services(TFSIX Quote) have accomplished mission impossible: beat the benchmark S&P 500 index.

The mutual funds steered clear of riskier stocks and held cash. During the 12 months ending May 21, financial funds lost 38.1% of their value, while the S&P 500 dropped 34.4%, according to Morningstar. Financial funds would have slumped even more were it not for the rebound that started in early March. Citigroup(C Quote) shares, for example, quadrupled in a matter of weeks after declining to less than $1. Bank of America(BAC Quote) is trading at around $11 after falling to as low as $2.53 at the end of February.

FBR Small Cap Financial, Burnham Financial Industries and Mutual Financial Services could make interesting choices for investors seeking cautious ways to bet on a revival of financials.

FBR Small Cap Financial fell 5% in the past 12 months. To protect shareholders, manager David Ellison had 57% of assets in cash at the end of 2008. Under normal conditions, he holds little cash. But last year he correctly determined that rising defaults presented extreme hazards. "When nonperforming loans are rising, bank stocks don't do well relative to the market," he says.

Ellison learned the virtue of taking special precautions during the late 1980s, when he managed Fidelity Select Home Finance(FSVLX Quote), which focuses on mortgage lenders. At the time, overbuilt real estate markets suffered high vacancy rates and many savings and loans collapsed.

Despite the troubles, most fund companies clung to their traditional strategies, staying invested in stocks. But Peter Lynch and other aggressive managers at Fidelity Investments believed in ranging widely, following different strategies as conditions warranted. Lynch, who managed Fidelity Magellan(FMAGX Quote), bought large financial stocks one year and small consumer companies the next.