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Are the Hottest Funds of 2006 Worth Buying?

Why first-quarter winners are a losing proposition, plus an alternative top 10.

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There's something particularly dangerous about lists of year-to-date fund returns when the year is still young. They capture such a short period of time, yet the returns of the leaders are always so darn enticing. Someone new to fund investing might think, "Why, if they just keep making that kind of return each quarter, I'll make a killing." Or perhaps they think that management has tapped into a growing trend, which is about to break wide open and make even more money. Unfortunately, such assumptions almost always end up costing investors money.

So, please, approach such lists warily. The top performers from the first quarter of 2006 are a case in point. Across the board, these funds have high costs and are extremely volatile, and some have lousy managers. Because of these traits, the odds are quite slim that if you bought one of these funds today you'd be happy with your decision 10 years from now.

Ten Funds Hot Enough to Burn
The kind of super-volatile, high-cost funds found in this quarter's top-10 list tend not to last long in investors' portfolios, or really at all. The fact is, a lot of these funds get killed off eventually. Alas, many trendy funds from years past--such as Steadman Oceanographic, Kinetics MidEast Peace, and Amerindo B2B--aren't around anymore.

 Top-Performing Funds in 2006
Fund NameYTD Return
Oberweis China Oppor (OBCHX)36.64
U.S. Global Invest Wrld Prec Min (UNWPX)34.50
Frontier MicroCap (FEFPX)33.34
U.S. Global Investors Gold (USERX)32.62
Dreyfus Premier Greater China (DPCAX)29.38
Gartmore China Oppor (GOPIX)27.10
ProFunds Ultra Small Cap (UAPIX)26.89
Firsthand Technology Innov  (TIFQX)24.55
ProFunds Ultra Real Estate (REPIX)24.00
Reynolds (REYFX)23.97
Returns through 03-30-06.

Consider that only three of these 10 have a 10-year track record, and none of those three are appealing, despite their big first quarter. U.S. Global Investors World Precious Minerals has gained 4.99% on an annualized basis over the past 10 years, U.S. Global Investors Gold has a 4.89% annualized loss for the period, and Frontier MicroCap has posted an appalling 10-year annualized loss of 29.73%.

I'd bet that maybe one of the funds in this list will provide a nice return over the next 10 years, but even that one may produce poor results for its average shareholder because it's so hard to time these funds right. To make money in a highly volatile fund, you need to have the courage to buy when it isn't hot (ideally when it's in the red) and then hold on through the horrifying losses.

Ten Funds Boring Enough to Depend On
I propose an alternative to the standard list of first-quarter winners. Instead of simply looking for the hottest short-term performance, I used  Premium Fund Screener to create a list funds you'd actually want to own that also boast truly impressive performance.

First, I screened for funds that charge less than 1%, have a standard deviation no greater than that of  Vanguard 500 Index (VFINX), and carry Stewardship Grades of B or better. Nothing profound here, I'm just looking for solid long-term performers that won't throw you with wild gyrations from quarter to quarter. Then I ranked the funds that passed my screen based on their performance relative to their category. The top funds are listed in the table below.

 Solid Funds with Great Long-Term Performance
Fund10-Year
Cat Rank
10-Year
Return
Mairs & Power Growth (MPGFX)213.93
T. Rowe Price Capital Appreciation (PRWCX)212.38
Vanguard Wellesley Income (VWINX)28.75
American Century Equity Income (TWEIX)312.61
Fidelity Balanced (FBALX)611.06
Mairs & Power Balanced (MAPOX)79.88
Jensen (JENSX)99.88
T. Rowe Price Personal Strat Income  (PRSIX)108.05
American Funds American Balanced (ABALX)119.87
Vanguard Wellington (VWELX)1110.01
Data through 02-28-06.

Most of the funds that made my alternative list own some bonds, which helps to reduce volatility. These funds are a bit boring, but they provide way better odds of making money--and sleeping better doing it--than you could get by taking a flier on a fund with scorching short-term returns.

Russel Kinnel has a position in the following securities mentioned above: JENSX. Find out about Morningstar’s editorial policies.