The good news is that some of the most battered growth funds rode April's tech-stock rally to gains of up to 80% over the past month. Unfortunately, that's also the bad news.
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As investors, we're trained to see gains large or small as universally good. But in the fund world sudden, outsize gains should actually raise a red flag. Here's why: To ring up stock-like gains in a burst, a fund's investments have to be concentrated in just a few stocks or a thin band of one industry sector. While these outsize bets can lead to fat returns, they can lead to gut-wrenching losses, too. Most investors buy shares of stock funds for diversification and solid risk-adjusted returns, but funds at the top of April's scoreboard offer neither.
"One of the few rules that applies to all funds is that you've got to be doing something both different and dangerous to get huge outperformance," says Bill Rocco, a senior fund analyst with
. "And that can really backfire. If you look at a lot of funds with huge short-term returns, they've been hit really hard over the past year."
Indeed, despite their fat April gains, many of the funds that flew highest are still in the red this year and over the past 12 months. We all learned the risks of chasing hot performers over the past year: The falling
has hacked more than 22% and 45% off the average big-cap growth and technology funds, respectively, according to Morningstar. Today, as part of our
Lessons From the Fall series, the Big Screen is sifting out April's top-performing funds to show why investors might be well-served to see their April gains as reason to give these funds a wide berth, not buy shares.
If we screen out funds from
that routinely turn up on top- and bottom-10 lists because they use leverage to post 150% of the gains or losses of an index, a screen of the top-performing growth funds still turns up some remarkably racy fare.
On average, the top-five large-, mid- and small-cap growth funds are up more than 62% over the past month, more than twice their average peers.
These funds, which have "diversified" labels, rang up these gains by putting, on average, almost 70% of their money into tech stocks, according to Morningstar.
Berkshire Focus fund, for instance, had more than 90% of its money in tech stocks at the end of last year, while the comparatively tame
Invesco Blue Chip Growth fund had 59% of its money in the tech sector at the end of the first quarter.
You'll also find renowned gunslingers on this list, like Garrett Van Wagoner, whose eponymous funds are known for their mercurial returns.
All of these funds' tech taste put them in the sweet spot in April, which might get them some attention. But their losses over the past year reveal the cost of making a big bet on one sector: You're along for the ride whether it's going up or down. That's why these funds, even with their bonny April, are down more than 40% over the past 12 months.
The upshot is that inordinate gains expose a fund's risks just as much as inordinate losses.
"Volatility on the upside is fun, but on the downside it's really painful," says Ron Roge, a financial adviser based in Bohemia, N.Y. "They can correct just as quickly as they went up, so big short-term returns are an indication of where they're invested and how much risk is there."
If you absolutely, positively have to own shares of these funds, it might be best to think of them as tech sector funds, which usually merit 10% or less of a diversified portfolio's assets. This way, you can benefit from these funds' highs, without losing your shirt when they enter their inevitable valleys.
If you're shopping for core, diversified funds, these funds show us why it's best to consider a fund's gains as much as its losses. If a fund trounces all of its peers in a given month, there's a good chance it will be at the other end of the spectrum before long.
Fund Junkie runs every Monday and Wednesday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
email@example.com, but he cannot give specific financial advice.