January 10, 1998

One Person’s Trash …

Tim Quinson Bloomberg News

If you’re looking for a mutual fund that’s likely to generate above-average returns in 1998, you may want to buy a fund that suffered net cash outflows last year.

The search would lead investors to funds that hold Asian stocks and others that buy communications stocks, said Susan Dziubinski, an analyst at Morningstar Inc., a Chicago-based research group. Both of these fund groups had net investor redemptions in 1997, she said.

“Don’t follow the crowd,” Dziubinski said. “Funds that are unpopular one particular year go on to beat the average equity fund during the next one-, two-, and three-year periods about 78 percent of the time.” And that holds true whether the funds are winners or losers during the base-year period - just look at whether they’re being bought or sold. To determine what makes a fund popular, the Morningstar study looked at the cash flows - or the amount of money going in or out of mutual funds - since 1987. The review found that most investors sell funds at the wrong time, creating an environment where opportunists can clean up by buying the funds that others seem to be selling, Dziubinski said.

That was the case last year when communications funds posted higher returns than diversified U.S. stock funds in a period when investors were pulling cash from communications funds, she said.

The average communications fund was up 25.98 percent in 1997; the average diversified equity fund advanced 24.44 percent, according to Morningstar. Investors missed an opportunity in 1996 to buy communications funds and the trend continued in 1997, Dziubinski said.

The communications funds that Dziubinski recommends are Invesco Worldwide Communications, T. Rowe Price Media & Telecommunications and Gabelli Global Interactive Couch Potato.

Asia-Pacific funds may be the exception that proves the Morningstar rule; investors added money to these funds in 1996, and they fell 26 percent on average in 1997. Last year, investors withdrew money from these funds, and the Morningstar principle holds that they should, therefore, rise this year.

As investors consider whether to buy unpopular funds, they should consider selling funds in popular categories such as those investing in real estate stocks and financial services stocks, Dziubinski said.

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