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Kathy Panagopouloskathy.panagopoulos@morningstar.com
Love a Bargain? Morningstar Reveals That 'Unloved Funds' Can Offer Value and Returns
CHICAGO, Jan. 13, 2005 – It’s the golden rule of investing: buy low, sell high.  To find those low-priced bargains, investors might do well to hunt within sectors shown to be the most unpopular by Morningstar’s ninth annual “Unloved Funds” study.

To determine which funds are “unloved,” Morningstar looks at equity mutual fund categories, noting which had the greatest percentage increase in inflows and which had the biggest percentage of outflows. The study’s outcomes--which were released today in the January 2005 issue of Morningstar FundInvestorTM--show that being a contrarian can have its rewards.

“Fund flows tend to follow recent performance, but investors buying into sectors that have already been bid up are unlikely to uncover many bargains,” explained Russel Kinnel, editor of Morningstar FundInvestor.  “The ‘Unloved Funds’ study is our way of illustrating which categories may be attractive.  If investors adopt a contrarian style of investing--even if it is only a small part of their portfolios--they may find better results than if they simply followed what others are doing.”

Morningstar’s “Unloved Funds” study has found that the stock-fund categories with the past year’s greatest outflows in percentage terms usually beat the average equity fund during the next three years, while the most popular categories of the year underperform during the same time period.  Morningstar introduced this study in 1996, after tracing fund flows back to 1987.

Unloved in 2004
In 2004, three sector fund categories posted the largest percentage of outflows:
  • Utilities – After two years of being unloved (2002 and 2003), utilities funds put up great returns in 2004.  But investors stayed away due to the sector's dismal returns in years past.
  • Financials – Performance was steady in 2004, with this category returning more than 13 percent on average, yet investors, wary of rising interest rates, avoided the funds.
  • Technology – With big losses for many of the past five years, it's easy to understand why investors would stay away.  Surprisingly, this is the first time since 1993 that this category made the list.   

During the past year, the three most popular sectors were natural-resources, Japan, and world allocation funds.  These areas were helped by rising energy costs and the weak dollar.

The Unloved Strategy
Morningstar suggests investors consider these parameters when putting the “Unloved Funds” strategy to work in their own portfolios:

Buy at least one fund from each of the three most unpopular fund categories.  
Any one category may continue to do poorly, so investors will greatly improve their odds if they diversify.

Be prudent.  
Some of the unloved categories are too narrow to serve as core funds, so they should be limited to a small part of the portfolio.

Be patient.
Investors should be prepared to hold unloved funds for at least three years, because it may take time for them to improve.  For example, utilities did not perform well in 2002 or 2003, but delivered in 2004.

Use a tax-sheltered account.  
The strategy is to buy and hold these funds for three years, so consider making the investment in a tax-sheltered account.

“Our study illustrates the dangers of chasing performance and the value of going against the grain,” Kinnel said.  “Jumping on the bandwagon of a sector that already has momentum and good press makes it hard to beat the market.  Why not instead embrace areas of the market that other people avoid and see if you can find some real values?  Our list of ‘Unloved Funds’ is a great place to start.”

About Morningstar, Inc.
Morningstar, Inc. is a leading provider of independent investment research in the United States and in major international markets.  The company offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions.  Morningstar tracks more than 100,000 investment offerings, including stocks, mutual funds, and similar vehicles.  The company has operations in 16 countries.

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©2005 Morningstar, Inc. All rights reserved.

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