Buy the Unloved 2017

This article was originally published in the January 2017 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor here.

For more than 20 years, Morningstar has recommended buying funds that others don't want as part of its "Buy the Unloved" strategy. This involves buying one fund from each of the three equity Morningstar Categories with the most calendar-year outflows and avoiding those with the most inflows. This contrarian approach asks you to put money to work in out-of-favor areas and to hang on for three to five years.

Over the long term, going against the crowd has improved results. Since 1993, the unloved groups have beaten the loved categories in most three-year periods. Overall, the unloved beat the loved by more than 5 percentage points annualized from 1993 through the end of December 2016. It works because investors often chase performance, thus signaling which areas may be overvalued or undervalued.

This year's unloved categories, based on flows for open-end and exchange-traded funds--excluding funds of funds--are large growth, European stock, and mid-growth. The categories to avoid in 2017 include large blend, foreign large blend, and diversified emerging markets. Here are some suggestions from the unloved:

Large Growth

We're about eight years into a bull market, and it's fair to ask if the next big move is down. For some protection in that inevitability, consider Silver-rated

European Stock

In 2015, European equity funds were among the loved categories. In 2016, Brexit spooked investors but also created opportunities for veteran managers with deep resources, such as Dean Tenerelli of Bronze-rated

Mid-Growth

In mid-cap growth, Chuck Akre is an uncompromising, bottom-up, buy-and-hold manager who invests in a handful of stocks trading at discounts to his estimate of their owner earnings, or profits left over after investments for upkeep and growth. Silver-rated

"Buy the Unloved" can be a good guide to contrarian ideas, but the strategy is best reserved for a small portion of your portfolio. Use it on the periphery of your long-term asset-allocation plan. It can help you exercise the urge to "do something" when the market makes big moves and remind you of the power of rebalancing away from the most-popular categories and toward the unpopular ones.