NEW YORK ( TheStreet) -- Plenty of mutual funds focus on high-quality stocks. Their portfolios include familiar names such as Coca-Cola (KO) and Johnson & Johnson (JNJ), companies with rock-solid balance sheets.But Aquila Three Peaks Opportunity Growth (ATGAX) takes a different approach. The fund specializes in stocks with below-investment grade ratings. Buying low-quality names has proved to be a winning formula lately. This year Aquila has returned 16.5%, outdoing the S&P 500 by 6 percentage points and topping 99% of competitors in the mid-cap growth category, according to Morningstar.
Among the top-performing low-quality funds this year is Putnam Capital Spectrum (PVSAX), which returned 18.2% this year, outdoing all its peers in the moderate allocation category. Putnam Equity Spectrum (PYSAX) returned 16.1% and outdid 95% of peers in the mid-cap value category. Perhaps the most notable low-quality fund is Fidelity Leveraged Company Stock (FLVCX), which returned 18.4% this year. During the past 10 years, the Fidelity fund returned 15.4% annually, ranking as the top-performing domestic equity fund tracked by Morningstar. Seeing the numbers, you may be eager to buy one of the low-quality funds. But keep in mind that low-quality companies tend to have weaker profits and grow more slowly than average businesses. Because of their shaky profiles, heavily indebted companies can fall hard in downturns as investors worry about the risk of bankruptcies. During the turmoil of 2008, Fidelity Leveraged Company dropped 54% and trailed 98% of its peers. Still, a low-quality fund can make an intriguing holding, providing extra gains in bull markets and helping to diversify a portfolio.