Buy the Unloved 2014

It's time once more to look at our annual "Buy the Unloved" strategy. It's a contrarian strategy driven by fund flows. The idea is to buy funds from stock categories with heavy redemptions and sell those with the greatest inflows. Over the past 20 years, it has worked pretty well because it's directing you to cheap assets and away from pricey ones as flows usually follow hot performers and flee areas with poor returns.

I wrote a preliminary article on Buy the Unloved in the January issue of FundInvestor, but now that we have final 2013 flow data, I can share the official figures with you.

Using a three-year holding period and assuming category average returns, the unloved funds returned an annualized 10.4% versus 6.4% for loved. Of course there's no guarantee those results will repeat, but it does illustrate the value in going against the grain.

I'm a long-term investor, so I see this more as suggested tweaks to a portfolio rather than something that would lead me to make wholesale changes. Add some to the unloved pile and trim from the loved. We use annual flows for categories to determine what's loved and unloved and then suggest holding for a minimum of three years. Typically, the strategy works best in big pivot years and less well when you have extended rallies for one part of the market.

For 2013, the strategy suggested buying large-growth, large-value, and large-blend. The three categories returned 33.9%, 31.2%, and 31.5%, respectively, in 2013. That's pretty good, as U.S. stocks proved to be winners, though small- and mid-cap stocks did even better. On the loved side, it suggested dumping emerging markets, foreign large-value, and real estate. Those categories returned negative 0.1%, 20.8%, and 1.6%. So far, the unloved are thumping the loved.

What about for 2014? The unloved categories are large-growth, precious metals, and commodities. It's easy to see why precious metals and commodities saw outflows as they had a brutal 2013, but as you saw above, large-growth was a winner.

On the loved side, foreign large-blend, diversified emerging markets, and large-blend attracted the most new money. The first two are similar to what we saw in the prior year, but large-blend has made a rare flip from the unloved to the loved in just one year.

Below are my ideas for actively managed open-end funds, but I think ETFs are a great idea, too.

Large-Growth Ideas
 Primecap Odyssey Growth (POGRX) is one of the best growth funds you'll find. It charges only 0.67% for a fund that does excellent fundamental research of growth stocks. It's a solid pick for the long haul.

 Manning & Napier Equity (EXEYX) is a team-run fund with a strong record. The same team of managers runs all of Manning & Napier's funds, blending top-down and bottom-up analysis to drive its portfolios.

 T. Rowe Price Blue Chip Growth (TRBCX) is a gem run by Larry Puglia, who is in his 20th year on the fund. Puglia has produced top-quintile returns across the one-, three-, five-, and 10-year periods without taking any extreme risks.

 Jensen Quality Growth (JENSX) hits both the unloved button and the quality emphasis that GMO suggests. It's a patient, large-cap, high-quality fund run by an experienced team out of Portland, Ore. The fund generally holds up better than its peers in downturns, so it's got defensive appeal.

Commodities Idea
 Harbor Commodity Real Return Strategy is run by PIMCO's Mihir Worah. Worah combines Treasury Inflation-Protected Securities and swaps linked to the Dow Jones UBS Commodity Index to produce a two-pronged strategy for fighting inflation. It's a great strategy, though it does have some interest-rate risk because of the TIPS side. The fund is very similar to  PIMCO Commodity Real Return Strategy (PCRIX). I'd suggest buying whichever version of those funds comes cheapest to you including expenses and possible transaction fees. They are best held in tax-sheltered accounts.

Precious-Metals Idea
With a 47.8% loss in 2013,  Oppenheimer Gold & Special Minerals (OPGSX) is the epitome of unloved. The fund is fairly aggressive and therefore tends to have big rallies and big drops. A good fund, but please use in moderation.

 

	FundInvestor Newsletter
	Want to hear more from the mutual fund experts? Subscribe to Morningstar FundInvestor for exclusive research, coveted analysis and proprietary ratings—neatly packaged and delivered to your inbox.	One-Year Digital Subscription 12 Issues | $125 Premium Members: $115 Easy Checkout