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.Read Full Transcript
Benz: So, the study looks at just equity-fund inflows and outflows, but in your recent research report, you also pointed to some fixed-income categories that have been among the biggest asset gatherers. You noted that given how low yields are, investors who are flooding into those funds may not see terrific returns ahead. Let's talk about the biggest asset-gathering in fixed-income categories?
Reichart: Sure. Those were intermediate-term bond, which had the most inflows in 2012 since 2009, short-term bond, and then high-yield bond, showing that investors are still really reaching for yield. And 2012 actually was a record-setting year for the high-yield bond category in terms of inflows.
Benz: Katie, how should people use this research? I assume that you're not going to say that people should completely upend their portfolios every year. How can they stitch it into a portfolio strategy that's otherwise pretty strategic in the long term?
Reichart: Right. It can be used just on the margin, so much like you do rebalance your portfolio by trimming outperformers and adding to underperformers. Here, you can look at the funds you already own and maybe add to ones in categories that are the unloved and trim out the loved categories. Or people might be a little more tactical and allocate a small percentage of their portfolio to this strategy.
Benz: The minimum holding period, though, if you are using the strategy if and you are rotating into some of these unloved funds, you want to hold them at least three years?
Reichart: Yes, at least three years.
Benz: Let's discuss some picks that sync up with some of the categories that you've highlighted as being the least loved. Let's start with large growth because we have seen a long-term trend here of outflows from this category. If someone's looking to maybe top up their allocation to this very unloved category, what are the couple of funds that you would recommend investors look to?
Reichart: We like Jensen Quality Growth, which has a Morningstar Analyst Rating of Gold, and that strategy has been in place for many years. They look for returns on equity of at least 15% over the trailing 10 years, and that just as you'd expect has held up really well during down periods.
Benz: You have a PRIMECAP fund on your list, as well. PRIMECAP Odyssey Growth is another fund that the analysts like, and it's a way to access these managers, who I believe aren't available in some other forms.
Reichart: Right. Some other Vanguard versions are closed, and this pick is a little more aggressive growth play.
Benz: And Harbor Capital Appreciation is another one?
Reichart: Yes, and that one, the manager's been around since 1990 and has just done a really good job there.
Benz: Large blend and large value were two other categories that hit your radar as being extremely unloved currently. Let's talk about a couple of picks within that large-blend category, which tends to appear in a lot of investors' portfolios anyway?
Reichart: Right. One we like is Manning & Napier Equity, and that's a little bit of an all-cap portfolio. It combines really value, cyclical plays; it even weaves in some top-down analysis. And it's been a really strong long-term performer.
Benz: How about large value?
Reichart: T. Rowe Price Equity Income is one we like. Manager, Brian Rogers, has been running the fund for over 25 years and it's just been really steady performer in all market environments.
Benz: Katie, well thank you so much for sharing this research.
Reichart: Thank you for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.