Seeking a Financial Refuge

By Dean Foust and Lauren Young

The easy-money mindset that pervaded everything from subprime mortgages to private equity has faded, leaving many Wall Street watchers fearful of a credit crunch that might take down the economy. So how can you protect your portfolio?

While most money managers think the broader markets and the economy will ride out the choppiness, they suggest some defensive moves until things settle down. Of the dozens of top managers surveyed by BusinessWeek, many were trimming back their stock exposure in certain areas, boosting their cash holdings, and heading to safer ground with higher-quality bonds. "We just told our people this is no time to be a hero," says David Darst, chief investment strategist for Morgan Stanley's Global Wealth Management Group, who recently raised his recommended cash position a couple of percentage points to 13%. Here's a look at how the smart money is playing the market:


Most advisers say they've trimmed their recommended equity stakes for conservative investors from, say, 55% to 50%. Meanwhile, they're shifting out of small and midsize companies and into such multinationals as General Electric (GE), Coca-Cola (KO), and Caterpillar (CAT). Right now, the bigger stocks are a bigger bargain. After the recent turbulence, the price-earnings ratio for the Standard & Poor's 500-stock index, based on profit estimates for the next 12 months, has dropped to 15.3, its lowest level since 1995.

And large companies like GE deliver steady growth and stand to profit from the dollar's ongoing slide, which makes exports more competitive. "If you are really in the business of thoughtfully growing capital, boring is good," says Thomas P. Melcher, chief investment officer at Hawthorn, a wealth management unit of PNC Financial Services Group.

Still, not all boring blue chips are automatically a buy. Financials are especially risky, given the sector's troubles. Consumer discretionary stocks are also vulnerable if heavily indebted Americans pare back their spending. Sectors like health care, software, and industrials make the most sense, say experts. "This is the type of marketplace where quality dominates," says Walter V. Gerasimowicz, CEO of Meditron Asset Management, which manages $600 million.


After a long stretch during which investors chased the bigger yields offered by risky plays, there's now a flight to quality in fixed income as well. But many pros say they're bypassing traditional Treasurys -- the benchmark 10-year bond is yielding just 4.79% -- in favor of corporate bonds with good credit and yields above 6%. And since there isn't much difference in the rates between short-term and long-term bonds, they're sticking with investments that mature within two to five years. "You're not getting enough yield to extend out to 30 years," says Mark Kiesel, an executive vice-president at bond giant PIMCO.

Investment-grade bank loans also look appealing. The group has gotten smeared along with the junkier segment in the recent credit squeeze, so many such loans now yield a fat 9%. But they're less risky than many corporate bonds since investors are paid off first in the event of default. Financial planner Morris Armstrong's top picks among bank loan funds: the Oppenheimer Senior Floating Rate Fund and Hartford Floating Rate Loan Fund.

Hedged Bets

If you want a little insurance against a full-on downturn, you can buy put options on the major indexes or a fund that bets on falling stocks. Matthew McCall, president of Penn Financial Group, is putting a slice of his clients' assets into the UltraShort Financials ProShares, an exchange-traded fund that's designed to go up when financials fall. He's also adding Ultra-Short Consumer Services ProShares, another ETF, because as he sees it, it pays to be prepared.


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