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Loving the Unloved

Study Suggests Good Payoff in a 'Contrarian' Fund Strategy

January 27, 1998|TOM PETRUNO

If you like the idea of going against the herd, mutual fund tracker Morningstar Inc. offers a simple "contrarian" investment idea: Put some money into the stock fund sectors that most investors didn't want in 1997.

The most unloved fund sectors last year, as measured by the lack of new cash going into them: communications industry funds, diversified Asian funds and Asian funds that exclude Japanese stocks.

Morningstar's strategy of buying the unloved sectors has a pretty convincing record of success over the 10 years the firm has been tracking it.

"Seventy-eight percent of the time, funds that are unpopular among investors in one particular year go on to beat the average equity fund during the next one-, two- and three-year periods," says Susan Dziubinski, analyst at Morningstar in Chicago.

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In 1996, for example, the least popular fund categories as measured by cash flows were communications industry, utility and Latin American.

In 1997 the average communications industry fund gained 25.8%, while the average utility fund rose 25.2% and the average Latin American stock fund was up 25.4%, Morningstar says.

All three handily beat the average stock fund's gain of 17.3% for the year. (Although, as with almost every other category, the unloved funds lagged the blue-chip Standard & Poor's 500 index total return of 33.4%.)

What's more, the fund sectors that were most popular in 1996, as measured by cash flow, all trailed the year's unpopular fund sectors in 1997.

Investors were hungriest in 1996 for real estate funds, mid-cap growth funds and emerging-markets funds. In 1997, real estate funds rose 22% on average, mid-cap growth funds rose 15.5% and emerging-markets funds fell 3.9%.

Buying into unloved fund sectors, as per Morningstar's definition, isn't foolproof. One of 1995's unloved sectors--gold funds--lagged the average general U.S. stock fund in 1996, and crashed last year as gold's price sank.

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Still, the strategy's winning percentage over the last decade is impressive, Morningstar notes.

"The counterintuitive strategy could only work if [most] investors have lousy timing," Dziubinski says. "And they do."

In other words, most people chase the investments that have already done well while ignoring investments that are depressed and thus potentially undervalued.

Dziubinski recommends making a modest bet in a fund or two in each of last year's unloved categories. In total, don't invest more than 5% to 10% of your investment portfolio this way; think of it as "spice" for your core portfolio.

Some ideas in each:

* Communications. Despite last year's big move, many communications industry funds still didn't attract much in new money. Hence, the group still shows up as unloved by Morningstar's standard. It suggests taking a look at Invesco Worldwide Communications, T. Rowe Price Media and Communications and Gabelli Global Interactive Couch Potato.

* Diversified Asian funds. Asian stock markets plummeted with the region's collapsing currencies in 1997, so it's no surprise that many investors fled these funds. Morningstar thinks the time is ripe to check out such funds as Vanguard International Equity-Index Pacific; Putnam Asia Pacific Growth; and a closed-end fund, Morgan Stanley Asia Pacific (which closed Monday at $7.81 on the New York Stock Exchange; ticker symbol: APF).

* Asian funds that exclude Japanese stocks. This is a separate category because most diversified Asian stock funds have a large chunk of their assets in Japan, a developed market, while most other Asian markets fall into the emerging-markets category. Morningstar likes Matthews Pacific Tiger; Colonial Newport Tiger; and a closed-end fund, Asia Pacific ($7.69, NYSE; ticker: APB).

In the case of the two closed-end funds--Morgan Stanley Asia Pacific and Asia Pacific--the former now is priced at a discount to its net asset value, and the latter is about even with net asset value. That's important because the danger with closed-end funds is in paying a premium over net asset value.

Bad News Broncos: As if Wall Street didn't have enough to worry about, the Denver Broncos' victory in the Super Bowl was a bad omen for the stock market--if you trust the "Super Bowl indicator."

This market-prognostication theory holds that U.S. stocks should rise in a year when the National Football Conference team wins and that stocks should fall in a year when the American Footbal Conference team wins.

It's not quite as simple as that, however: The indicator counts as NFC teams the three AFC teams that were part of the old National Football League before it merged with the American Football League in 1970 (the Pittsburgh Steelers, Indianapolis Colts and former Cleveland Browns, now the Baltimore Ravens).

The Super Bowl has been played for 31 years (not counting Sunday's game), and the Super Bowl indicator has been accurate 90% of the time. That is another way of saying that the AFC, excluding the Steelers' victories, has lost most of the time--and that the stock market has mostly risen since 1970.

When the AFC Miami Dolphins won the Super Bowl in 1973 and 1974, the market suffered two of its worst years of the post-World War II era.

The AFC L.A. Raiders won in 1984, which also was a down year for stocks overall. Coincidences? Maybe. But with 1998 off to a nervous start, Green Bay was clearly Wall Street's team.

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Tom Petruno can be reached at tom.petruno@latimes.com

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