As Valentine’s Day nears, some advisors and investors may want to take a “romantic” look at funds, says Morningstar’s Russell Kinnel.
Each year, the group’s director of manager research reviews fund flows and puts together an “unloved,” or unpopular, list of fund categories. Investors then can add funds from three unloved categories with the greatest outflows in the prior year, since they may be due for “a rebound”; likewise, the strategy involves selling funds in three “loved” categories, which had the largest inflows in the prior year and “may be overheated,” according to Kinnel.
“This is a strategy that we have tracked for more than 20 years, and it has proved to be surprisingly resilient,” he stated in a recent online report. “It’s really a pretty basic contrarian strategy driven by mutual fund flows. The idea is to look at calendar-year mutual fund flows by Morningstar Category and go in the opposite direction.”
But you can’t love ‘em and leave ‘em, the analyst points out: “The strategy says you buy funds in the three most redeemed categories and sell funds from the three most heavily purchased, then hold on for three or five years.”
Staying in the relationship for several years, Kinnel argues, produces positive results. “Since 1994, unloved categories have beaten loved categories in all but one three-year period. On average, the unloved have beaten the loved by 377 basis points annualized,” he explained.
Which groups top the charts this for being unloved? Large blend, large growth and large value. And which ones need a little less romance? Foreign large blend, Europe and health care.
Going through the unloved groups, Kinnel compiled this list of top picks for investors and advisors to consider:
- Large blend: Vanguard Total Stock Market Index (VTSAX), Oakmark (OAKMX), AMG Yacktman (YACKX) and T. Rowe Price Dividend Growth (PRDGX);
- Large growth: T. Rowe Price Blue Chip Growth (TRBCX), RiverPark/Wedgewood (RWGFX) and Jensen Quality Growth (JENSX).
- Large Value: Sound Shore (SSHFX), American Century Value (TWVLX) and Artisan Value (ARTLX).
The Vanguard Total Stock Market Index Fund, which has a five-star Morningstar rating, is a good low-cost option, according to the Morningstar research director, “and it can simplify investing given how widely dispersed the portfolio is.”
For more active strategies, he points to Oakmark (four stars) and AMG Yacktman (four stars). “Both have excellent stock-pickers with the potential for tremendous outperformance,” Kinnel stated.
The five-star T. Rowe Price Dividend Growth Fund “plays the role of Goldilocks here with a still active but milder strategy of investing in companies with solid growth prospects and healthy balance sheets that are capable of boosting dividend payouts,” he adds. Large Growth
In the large-growth group, Kinnel is a fan of Primecap funds, but he also says the five-star T. Rowe Price Blue Chip Growth Fund “is a real gem” thanks to veteran manager Larry Puglia’s ability to find companies with high returns on capital and sustainable earnings.
For a more contrarian-focused play, the fund specialist likes the three-star RiverPark/Wedgewood fund led by David Rolfe, though its energy holdings have held back performance of late.
For a growth fund that can “play defense,” there’s the five-star Jensen Quality Growth Fund, which buys companies that have shown they can hold up well in recessions, according to Kinnel.
Sound Shore’s three-star fund includes 40 stocks and limits positions to 3.5% of the portfolio.
“It also avoids deep-value stocks, which tend to be higher risk as well as higher reward. Rather, it favors stocks that have shown some signs of recovery and have strong competitive positions,” explained Kinnel. “The end result is a fairly consistent portfolio and performance. Its desire for companies with competitive positions has led it away from materials and energy and into financials, tech, and healthcare.”
The managers of the four-star American Century Value Fund focus on firms with defensible franchises and shares in the cheapest third of the S&P 500. The fund’s emphasis on yield means it holds Exxon, Chevron and Occidental as top holdings.
For those feeling “really contrarian,” Kinnel suggests looking at the two-star Artisan Value Fund, which has 12% of its holdings in materials and 13% in energy. While recent returns have been “lousy … the team’s longer track record at other funds shows this is a decent bet for a rebound,” he states.
Sell the Loved, Sort Of
This means moving out of foreign large-blend, Europe and healthcare, according to Kinnel.
Most of the recent inflows into Europe-focused funds came into dollar-hedged European ETFs, he says: “So, I suppose this is a signal to bet against the dollar as much it is to bet against Europe.”
Be careful with the buy-the-unloved plan, the Morningstar analyst says, and don’t overhaul an entire portfolio based on this strategy.
“You don’t want to veer from your overall, long-term plan. Just use this strategy at the margins and as a healthy reality check to make you reconsider buying the most popular categories and rethink selling a fund from an unpopular area,” he explained.
— Check out Why Are Stocks Falling in Sync With Oil Prices? on ThinkAdvisor.