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By Christine Benz and Katie Rushkewicz Reichart, CFA | 01-23-2013 02:00 PM

Unloved Funds Worth Embracing

The large-cap spectrum saw the most outflows in 2012, which has created opportunities to buy several Gold-rated funds on the cheap.

Christine Benz: Hi, I am Christine Benz for Morningstar.com. When it comes to managing your portfolios, an ongoing Morningstar study shows that most investors would be better off taking a contrarian tack. Joining me to discuss that research is Katie Reichart. She is a senior analyst with Morningstar.

Katie, thank you so much for being here.

Katie Reichart: Thanks for having me.

Benz: This is Morningstar's annual Unloved Funds study. We've been running it for about 20 years. Katie, let's talk about the methodology that goes into this research that points to "Buying the Unloved" as being a strong long-term strategy.

Reichart: Sure. Well, each year, we use Morningstar asset-flows data to see what investors were buying and selling. We pick the three categories that have the biggest outflows--those are the "unloved" categories. And the three with the biggest inflows--those are the "loved" [categories]. And then, we put those in two separate portfolios and track the average category returns for the subsequent three-year period. Each year, a category will roll out and another one will be added.

Benz: In terms of how the strategy has performed over time. Let's talk about performance of the unloved basket relative to say a broad market benchmark as well as relative to those loved categories, where investors have been adding money. How is it done?

Reichart: It's done pretty well. So, the unloved strategy has gained 8.4% annualized since 1993, and the loved strategy is up just about 5.1% during that period. And the unloved strategy was competitive compared with the MSCI World Index, which was up just 6.9% during that period.

Benz: Let's look at the categories that saw the biggest redemptions in 2012, which according to the study would point to those being a potential buying opportunity?

Reichart: With the largest outflows, a lot of these categories have seen outflows for several years. [They were] large growth, large value, and large bond; so really across the large-cap spectrum. Those are the unloved categories.

Benz: Then among the categories that saw the biggest inflows, let's talk about some of those.

Reichart: Sure. On the equities side that would be diversified emerging markets, foreign large value, and real estate.

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