Fidelity's "Hot Hand" for 2010

01/12/2010 1:00 pm EST

Focus: FUNDS

Jim Lowell

Senior Partner & Chief Investment Strategist, Adviser Investments

Jim Lowell, editor of Fidelity Investor, describes his “Hot Hands” strategy, which has beaten the market for the past 27 years, and he names this year’s winner.

Of course, I know that past performance is no guarantee of future results. But I also know that ignoring past performance is a fool’s gambit. And as it happens, looking back over the last 20 years, [our] Hot Hands[strategy] has shown a pattern of consistent outperformance.

The concept couldn’t be simpler: Buy whichever [Fidelity] fund has performed best in the previous year and hold onto it throughout the upcoming one. The rewards, as demonstrated by over 20 years of data are stunning, to say the least.

[But] this strategy has not beaten the market every year. Our Hot Hand Fundfor 2008 was Fidelity Independence (FDFFX), which lost 48.1%, vs. the 37% loss for the Standard & Poor’s 500. In 2009, our Hot Hand pick was Fidelity Global Balanced (FGBLX), which delivered 22.5% vs. 26.5% for the S&P500.

Another caveat: I never advocate investing your entire savings in the latest Hot Hand fund. That would foolishly fly against the diversified investment approach that I practice and preach. That said, I believe that many growth-oriented investors could improve their performance by putting a reasonable (5% to 10%) portion of their money to work following my Hot Handstrategy.

Here are the ground rules for the strategy. First I looked at all of Fidelity’s retail diversified stock funds for each year between 1983 and 2009. I excluded single-sector (Select, Real Estate, Utilities) funds and balanced funds (those with significant bond positions). On the international side, I did include broad international funds, but I excluded the geographically non-diversified (single-country) funds.

Using the prior year’s performance as a guide for selecting Fidelity funds is highly profitable. And ignoring it, or going with the “dogs,” as some investment advisers who use a “contrarian” approach like to suggest, can lead to market-lagging results.

The methodology isn’t complicated. There’s no magic black box. But does it work? If at the end of 1983 when you would have put your money into Fidelity Magellan, through the end of this year, when you would have had your money in Fidelity Global Balanced (FGBLX), you would have netted a total return of 5,958%, while the return for S&P 500 would have been 1,196.4%.

On an annualized basis, that’s 17.1% for Hot Handsversus 10.4% for the market and just 9.1% for the “worst” fund, contrarian strategy.

The Hot Hand fund beat the index in just 15 out of 26 years. But it’s the accumulation of market-beating returns that really makes the difference. (The good years were better than the bad years were bad.) And over the long haul, this strategy soars like an eagle, when most other simple strategies fall like turkeys.

The 2010 Hot Hand? It’s Fidelity Latin America (FLATX)! (It rose more than 90% in 2009—Editor.)

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