Worthwhile Picks in Weak Fund Categories

NEW YORK (TheStreet) - Any investment can suffer occasional off years. But several categories of mutual funds have disappointed investors again and again, delivering subpar results over the long term and failing to achieve their goals.

The poor performers include high-yield municipals, market neutral, and commodities funds. Should you avoid the weak categories altogether? Some advisors think so. But by shopping carefully, it is possible to find a handful of funds in the categories that are worth owning.

Consider high-yield municipal funds. Low-quality bonds have been crushed in downturns. When the market collapsed in 2008, the category lost 25.3%, according to Morningstar. That was a shocking result for a fixed-income category. Last fall, the high-yield municipals again gushed red ink. Weighed down by the losses, the high-yield tax-free funds only returned 1.0% annually during the past five years, compared to 3.4% for intermediate-term national municipal funds, which focus on high-quality issues.

Long-suffering shareholders in high-yield municipal funds may not get any relief soon because some kinds of municipals are being hurt by persistent problems. Among the shakiest issues have been so-called dirt bonds, which were issued to finance development of single-family houses in Florida and other states. When the housing markets collapsed, so did the bonds -- and rebounds are not likely for years to come.

Other troubled issues are tobacco bonds. These were created after cigarette makers --including the predecessors of Altria (MO) and Lorillard (LO) -- agreed to pay 46 states $200 billion over 25 years.

States such as Ohio and Illinois issued $56 billion worth of municipal bonds backed by revenues from the cigarette companies. But in 2009, sales of cigarettes dropped by 9%. As a result, the risks of bond defaults are greater, and the tobacco bonds have sunk. Now some analysts worry that cigarette sales will continue falling for years as more smokers quit because of health concerns or the rising costs of the habit.

To get higher yields while avoiding most tobacco and dirt bonds, consider Franklin High Yield Tax-Free Income (FRHIX), which has returned 3.1% annually during the past five years.

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