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Stock tip: invest in 'unloved' funds

It's IRA time, with people planning to open individual retirement accounts after doing their tax returns and then fretting over where to invest the new money.

If you already have a balanced mixture that invests in the total U.S. stock market, a diversified international fund and a bond fund, and want to add some spice, you might want to pick a fund that disgusts you.

Yes, you read that right. I'm talking about picking an ugly fund, one that people haven't wanted to touch for the past three years.

Why? Stocks and funds run in cycles. They are sweet for a while, then turn ugly, and eventually become darlings again. So a strategy suggested by Morningstar since 1994 is to choose what it calls "the unloved," a fund that has been snubbed in the marketplace.

I'm not talking about a fund with a lousy manager or that has high fees. Rather, I am talking about a fund that invests in a certain category, one most people consider unpopular at the time. In the mid '90s, such a category was gold. When Morningstar suggested buying the unloved precious metal funds of 1995, the idea sounded ridiculous. For years, gold had been a loser. Then in 2000, gold started to win favor with investors and, a few years later, it was the darling of investors, and the SPDR Gold Trust fund became one of the most popular funds sold.

As Morningstar has studied its "unloved" strategy, however, it has found that unpopular funds can be detested for a long time, sometimes years. So the firm's analysts suggest that people buy only a little and that they simultaneously invest in the three most unpopular categories from the past three years. Together, each year's three unloved funds have gained, on average, 8.4 percent a year from 1993 through 2012, Morningstar's Katie Rushkewicz Reichart said. That compares with a 6.9 percent average annual gain in the MSCI World Index, an index that reflects the stocks of the world in aggregate.

Note that you don't pick the three based on how awful their returns have been for three years. Rather, you pick them based on how much people have come to detest them, indicated by investors leaving in droves.

So the unloved group that you would buy this year would include a large-cap growth fund, or a fund that picks stocks of large companies with fast growth — companies like Apple — and a large-cap value fund, or a fund that picks large companies that are cheaply priced. In addition, you would pick a large-cap blend fund, or a fund that picks a variety of large companies, some fast growers and some that are more sluggish, but all with cheap stock prices.

Investors holding such funds did well in 2012, earning double-digit gains. But under the strategy, that's not why you buy them. Instead, you select the three because investors haven't wanted them. Last year, investors yanked $39.5 billion from large growth, $16 billion from large value and $14.4 billion from blended funds.

Rushkewicz Reichart suggests these unloved-type funds: LKCM Equity, Vanguard Growth Index, Dodge & Cox Stock and Vanguard Dividend Growth.

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune.

Stock tip: invest in 'unloved' funds 03/24/13 [Last modified: Sunday, March 24, 2013 6:48pm]

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