Buy the Unloved With ETFs
A lower-cost way to play the unloved.
At Morningstar we've been writing for more than a decade about a strategy that invests in asset classes that investors are selling and sells asset classes that investors are buying. We call this strategy, "Buy the Unloved." Today, exchange-traded funds offer a new way to put this strategy to work.
The Original Strategy
The premise behind buying the unloved is simple: Fund flows chase returns, and the combination of flows and strong past returns are good indicators that an asset class is overvalued. Internet funds in 1999 or real estate funds in 2007 are examples of why you wouldn't want to buy the most popular fund categories. On the flip side, you would have done well buying small-value funds in 2000, when other investors were not.
Here's how the strategy works. Invest in mutual funds from the three equity categories that received the greatest redemptions in the prior year. (Bond funds and asset-allocation funds are excluded.) Then do the same thing the next year and the next year. After three years (or four or five--those time periods work just as well), you start rolling over that original group of funds in the next group of unloved.