Large-cap U.S. is the contrarian play.
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Each year we let you know where the Buy the Unloved strategy suggests you should invest. The idea is to buy funds from the three least-popular equity categories and sell those from the three most-popular. Popularity is determined by fund flows for the prior calendar year.
Holding the unloved funds for three to five years and selling or trimming the loved for that same period have yielded strong returns over the years. However, the results are lumpy. They work beautifully when there's a dramatic pivot year like 2008 or 2009, but they lag in years when category performance is more consistent. This indicates a couple of things. First, you need to stick with the strategy for a while. Second, this is something to do at the margins of your portfolio rather than at the center.
So, how did the strategy perform? From the beginning of 1994 to the end of 2010 , the unloved earned 308% cumulatively or 9% annualized. That's far better than the loved, which earned 157% cumulatively or 6.1% annualized. The MSCI World Index returned 4.6% annualized, and the S&P 500 returned 8% annualized.
This year's unloved categories are large growth (outflows of $45 billion), large blend (outflows of $17 billion), and large value (outflows of $4.5 billion). The loved are diversified emerging markets (inflows of $28 billion), foreign large blend (inflows of $18 billion), and commodities broad basket (inflows of $4.2 billion). Below I have selected some of the best actively managed and passively managed funds for playing the three unloved categories. Among active options, because the strategy is really a bet on an undervalued asset class, I opted for funds that are fairly straightforward and not among the quirkiest of options.
In large growth, I suggest Harbor Capital Appreciation
Among large-blend funds, I like Vanguard Dividend Growth
In large value, Dodge & Cox Stock
Russel Kinnel is director of mutual fund research with Morningstar.