8 Unloved Funds to Consider

Focus: FUNDS

Katie Reichart of Morningstar shows how investing contrary to market sentiment can pay off in the long run.

Each year we look at the equity categories that have experienced the greatest outflows and inflows to gauge which areas of the market are unloved or over­heated.

The idea is to use fund flows as a contrarian indicator, buying into categories that have seen inves­tors leaving in droves while trimming exposure to those that have experienced a lot of interest. We have tracked this strategy since the early 1990s, and this research indicates that holding funds in the unpopular categories for at least three to five years is an effective approach that yields strong results.

Using fund flows data for the year to date through November (the most recent available), the most popular equity categories in 2012 were diversified emerging markets (inflows of $20.6 billion), foreign large-value (inflows of $5.3 billion), and real estate (inflows of $3.8 billion).

Those looking across asset classes might want to be cautious about sending new money to intermediate-term bond (inflows of $104.9 billion), short-term bond (inflows of $31.7 billion), and high-yield bond (inflows of $24.5 billion), particularly as interest rates have nowhere to go but up.

The most unloved equity categories are also the most unpopular overall: large-growth (outflows of $34 billion), large-value (outflows of $19.7 billion), and mid-growth (outflows of $9.1 billion). These catego­ries have seen outflows despite posting double-digit gains through mid-December.

The money leaving these categories reflects a broader trend of investors fleeing equity funds while piling into fixed-income offerings and passive exchange traded funds.