Go against the grain to find winners.
The final fund flow data for 2011 has come out, so it's time to talk about Morningstar's Buy the Unloved approach.
This is a strategy that takes its cues from fund flows. The basic idea is that the categories with the greatest inflows in the prior year are overbought and those that had the most redemptions are oversold and thus due for a rebound.
The idea is to buy the unloved, sell the loved, hold for a period of three to five years, then do it again. Over time, this tactic has produced pretty good results. It's been particularly effective in years when market leadership changes dramatically--so years like 2000, 2008, and 2009 were among the better ones.
Going back to the beginning of 1994 through the end of 2011, the unloved funds returned an annualized 8.98% versus 7.42% for the S&P 500, 3.92% for MSCI EAFE, and 5.13% for the loved.
More than an actual investment strategy, I see Buy the Unloved as a lens through which you can view your own portfolio shifts. If you were planning on dumping funds in the unloved categories and adding in the loved, you ought to think twice. You may be too late on both counts and setting yourself up to get whipsawed. Be sure that you are not confusing macro market movements with manager skill.
This year's unloved categories and their redemption levels are: large growth, negative $40 billion; large blend, negative $23 billion; and world stock, negative $16 billion. On the loved side, diversified emerging-markets funds took in $20 billion, commodities broad basket drew $9 billion, and foreign large growth gained $4 billion. (I exclude allocation and bond categories, though it can also work with the bond categories thrown in.)
Favorites From the Unloved Categories
If you want a pure asset play for the three unloved categories, consider our favorite low-cost ETFs in those areas.
Here are a few actively managed open-end ideas.