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.
Primecap Odyssey Growth POGRX
This fund lets you tap one of the best growth teams for just 0.68% in expenses. Not too shabby. They've done a great job here and over a longer period at the closed but similar Vanguard Primecap VPMCX. They do more deep fundamental research than most growth investors do. They are able to do that because they have much more experience and depth in their research team.
T. Rowe Price New America PRWAX
Joe Milano has produced top quartile performance during his nearly 10 years at the helm of this fund, yet its asset base is a rather small $2.4 billion. Milano takes a moderate approach with his growth-at-a-reasonable-price strategy. Over the years, stock selection has made this fund a winner.
Longleaf Partners LLPFX
It’s a classic, that’s for sure. Staley Cates and Mason Hawkins are excellent long-term investors. They run concentrated, occasionally cash-heavy portfolios with the aim of building wealth slowly without taking on too much risk along the way. They look for companies trading at a steep discount to intrinsic value and they'll allow cash to build if the market isn't offering any. They do a great job of aligning their interests with shareholders'; they invest large sums of their own money in the fund and they will close the fund when needed.
FMI Large Cap FMIHX
This is a tamer approach than Longleaf's, but still worth a look. Here you get a focused portfolio but with an emphasis on quality that gives the fund a little smoother ride than Longleaf does. The team running this fund has produced a cumulative 86.7% return compared with 33.4% for the S&P since the fund was launched at the end of 2001. Not too shabby.
Oakmark Global OAKGX
Clyde McGregor and Rob Taylor have done an outstanding job with their absolute value approach. Each runs a focused portfolio and the end result is a diverse but compact portfolio of about 40 stocks. The fund has generally been rather evenly split between U.S. and foreign stocks. The pair run it nearly fully invested, yet lost less than most in 2008 and have enjoyed strong performance since then.
Mutual Global Discovery TEDIX
This fund boasts two seasoned value hands. Peter Langerman and Phillipe Brugere-Trelat have been managers of the fund for only a couple of years, but their careers at Mutual Series date all the way back to the 1980s. I would expect the fund to act like most in the Mutual Series family: outperform on a risk-adjusted basis by losing less in downturns and lagging only a bit in rallies. They've loaded up on quite a few established but steady names in Europe and the U.S., such as British American Tobacco, CVS, and Royal Dutch Shell