If plunking money into last year's hottest funds is a known sin, doing the opposite will put you in investing's Valhalla, right? Not quite.
Each year since 1987, Chicago research house Morningstar has churned out a list of the three fund categories with the year's lowest net inflows. The year after they hit the most-ignored chart, these categories tended to rally, topping the average stock fund more than 70% of the time and dusting the three top-selling categories nearly 90% of the time. (For your information, communication, Latin America and Pacific/Asia funds earned the dubious honor in 2001.)
Sounds like a surefire hit, right? Unfortunately, no. While these data underline the value of not slavishly following the crowd, it's important not to run too far with the idea. Remember that volatile niche funds that focus on one industry or foreign region tend to make this list.
You don't want too many of these in your portfolio or you can expose yourself to unnecessary risk. And the categories that show up repeatedly on Morningstar's unloved-fund radar have often underperformed the market over time -- by far the more important measure for the long-term investor.
Betting the Ranch
Let's look at the 30 unloved categories singled out over the past decade. Asian or Japan funds have made the cut seven times; 2001 marked Latin American funds' third time on the list. Perhaps that's because funds that bet the farm on one or a few foreign markets are among the shakiest out there.
Asia funds, for instance, rocketed up 96% in 1999's tech-driven market -- yet they average an 8.4% annual
over the past five years. Latin American funds average an 1% annual loss over the same stretch.
Precious metals funds, best known as a place where money has gone to die over the past 10 years, have made the list twice. After earning unloved status in 1992, they promptly shot up 81% on average the next year. Despite these occasional bursts, however, the category still averages a 3.2% annual loss over 10 years.
The folks at Morningstar urge investors to use the data as an object lesson against performance-chasing -- not as an endorsement of these funds as must-owns.
"Thinking about this data can keep you from making the big mistake of jumping into a hot area," says Scott Cooley, a senior fund analyst at Morningstar. "But it doesn't always work, as you see with precious metals funds."
And while these funds' track record vs. the average stock fund sounds impressive, the number of sputtering and expensive funds out there diminishes that achievement a bit. Consider that the
Vanguard 500 Index fund, which meekly tracks the
index, topped the average U.S. stock fund over the past 10 years, doing so for six straight years from 1993 through 1998.
That said, this study shows why you should also think long and hard before casting your lot with the sector or style du jour. If you'd gone with the crowd in 1998 and 1999, for instance, when tech and tech-stuffed growth funds were highest performers and top sellers, you'd have found yourself in the epicenter of the Nasdaq's tumble since its March 2000 peak. Each of the three unloved categories from 1998, funds focused on Latin America, energy stocks and Asia, are in the black and beating the S&P 500 over the past three years. Small-cap value, mid-cap value and small-cap blend funds were the faves last year, if you're wondering.
Teach the Village People to Fish
Sensibly, the study comes with a suggestion that anyone fishing for turnaround candidates in the unloved pool should limit their investment to 10% or less of their portfolio. Given the esoteric nature of these unloved funds, it seems the best way to play this trend -- if you must at all -- is to use play money or the amount you might take to Las Vegas.
In the end, the lesson here is that sectors and styles shift in and out of favor in spastic fits, and trying to time those moves is often a fool's errand. In other words, a diversified portfolio is the best idea for the vast majority of us -- here's a
Want more proof? A little while ago the folks at Phoenix Investment Partners sent me a comparison of three hypothical portfolios. In each of the past 20 years, one herd-following investor sank $10,000 into the previous year's top-performing sector. Another contrarian type plunked that cash into the previous year's worst-performing sector. A third didn't get cute and simply slugged the money into a diversified portfolio, a la the S&P 500.
Guess who won?
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.