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Top Funds in Unloved Categories

Investors have been pulling money out of the large- and mid-growth categories, which may mean it's a good time to consider these quality funds.

Morningstar's most recent asset-flows report shows investors pulling some money out of U.S.-stock funds in May ($659 million to be exact), though not enough to put much of a dent in the year-to-date numbers, which show them adding $22.6 billion through the first five months. But even as investors show renewed interest in stock funds after years of outflows, not all equity-fund categories have been invited to the party.

In particular, the large- and mid-growth stock categories saw net outflows for May as well as the year to date. For large-growth, outflows are nothing new. As Morningstar's Katie Rushkewicz Reichart noted back in January, the large-growth category has seen annual net outflows since 2004. And it won't be a shock to see that trend continue in 2013 with large-growth experiencing net outflows of $10.4 billion through May. Mid-cap growth, on the other hand, has lost a mere $739 million so far this year (albeit in a category that is about one fourth the size of large-growth). But it lost $834 million in assets in May alone after losing $953 million the month before, so it will be interesting to see if this trend of outflows continues.

At the start of each year Morningstar's fund analysts look back at fund flows from the year before, highlighting categories that have seen large inflows or outflows. The idea is that fund flows can be contrarian indicators because categories that garner lots of investor dollars often become overheated while those that investors have fled often go on to earn outsized gains. Three-year return statistics bear out the effectiveness of this strategy.

That said, with the first six months of 2013 now in the rearview mirror, we thought we'd take a look at some of the top stock funds in two of this year's most unloved categories: large- and mid-growth. Using our  Premium Fund Screener, we screened for funds in these two categories that have garnered Gold or Silver Morningstar Analyst Ratings, meaning they've been vetted for the quality of their managers, process, price, performance, and parent company. We screened out institutional funds and those closed to new investors. We also screened out load funds, though investors who don't mind paying them or have access to load-free versions can simply remove that element of the screen if they wish. The full list can be seen  here (Premium Membership required). Below are three funds on it.

 Vanguard Capital Opportunity (VHCOX)  
|  Analyst Rating: Gold            
Bad news for this fund's asset base turned out to be good news for investors. In April this topnotch large-growth fund opened to new investors for the first time in nine years. The fund's Primecap management team looks for companies that have grown rapidly in the past but that have become temporarily undervalued. They typically hold stocks for long periods, as illustrated by the fund's low turnover rate (9%). Health care and technology are significant overweightings, making up more than 70% of the portfolio combined (as of March 31). The fund will occasionally lag its category partly because of its contrarian nature, but long-term performance has been stellar, with 10- and 15-year annualized returns in the top 2nd percentile of the large-growth category. Performance is helped by the fund's low annual fees (0.48%).

 Jensen Quality Growth (JENSX)      
|  Analyst Rating: Gold            
Underperformance during the past few years shouldn't deter investors from this large-growth fund. Two thirds of its concentrated portfolio of about 30 firms consists of wide-moat stocks as managers target companies with consistent high returns on equity. Turnover is low at 16%. As of March 31, the portfolio was overweight in industrial stocks (29% of holdings) and consumer defensive names (18%) while owning no energy or communications stocks. Top holdings include
 PepsiCo (PEP),  3M (MMM),  United Technologies (UTX), and  Procter & Gamble (PG), each at around 5% of the portfolio. From March 2005 through May 2013 the fund beat its typical peer during rolling five-year periods 95% of the time and beat the S&P 500 100% of the time. The fund has been smoothly transitioning to new managers over the years.

 Neuberger Berman Genesis (NBGNX)      
|  Analyst Rating: Silver           
An experienced management team, solid approach, and steady performance are among the reasons this mid-growth fund comes recommended. Its managers focus on small stocks that dominate a competitive niche and have solid balance sheets, strong cash flows, and reasonable valuations. Then they hold on to those stocks as they grow; turnover is usually about 20%. The fund carries a low Morningstar Risk rating, and its low-volatility profile is reflected in the fact that it tends to outperform during risk-averse markets but also tends to lag when more speculative fare does well. Formerly in the small-blend category, the fund moved to mid-growth in late 2011. Fees, at 1.03%, are below-average for a no-load, mid-cap fund.

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