(Published 06/01/2007) What's the #1 indicator that a fund category isn't going to perform well? The number of new fund launches in it.
Fund companies launch new funds when they spot an opportunity to make money – not for fund investors, but for themselves, in the form of fees paid by new shareholders. Frequently, the most "saleable" funds are those that have performed well in recent years, enjoyed a significant buzz, and received steady, positive media coverage.
During the final stock bubble years in the late '90's, fund companies launched new tech or growth funds every few days. Back then, brand-new tech funds could bring in hundreds of millions (if not billions) right from the get-go. A classic example was Merrill Lynch Internet Strategies, which launched on March 22, 2000 (within days of the market peak). The launch arrived just in time to bring in over a billion dollars (with a sales load…) before diving nearly 80% in the first year alone.
Today, most new fund launches are ETFs (exchange-traded funds) that run the gamut from countries to currencies and tech to telecom. Many offer access to extremely specialized commodities, currencies, or investment strategies. Traditional open-end mutual funds, on the other hand, are arriving with much less variety. Since December 2006, the majority of new funds are international funds (although some are global). No less than two dozen new international funds have been launched in the wake of that category’s recent sizzling performance. Many investors focus on specific "hot" areas in international markets, like international small cap or real estate investments. There's even a renewed interest in single-country open-end funds.
Apparently, investors aren't anxious about making international investments after they experience great returns. Quite to the contrary, they look for even more focused and risky ways to make their money. We last saw this behavior during the good old tech bubble days, when general tech and growth fund launches in the 90's morphed first into focused Internet funds, then later into new and different types of Internet and telecom funds – remember "b2b" (business to business) "content," and "Internet infrastructure" funds?
Another indicator that we use is fund investor money flow, which analyzes which funds investors are buying and selling. Since fund companies launch funds in sectors where they perceive a demand, it should come as no surprise that investors have been piling into international funds at a record pace. Virtually all new fund dollars are going into foreign funds, even though the U.S. market has been plenty hot itself in recent years. We’re talking tens of billions a month – the sort of numbers that tech and growth funds saw in early 2000.
As contrarian investors, we firmly believe in doing exactly the opposite of what the investing herd does. The more popular a fund category is today, the more likely it is to under-perform tomorrow. That’s why we're downgrading international diversified funds yet again, from a (Weak) to our lowest rating, a (Least Attractive). Back in 2002, we rated international funds a (Most Attractive), and they held on until April 2004, when we cut the category down to a (Neutral). This category continued to perform well. A year later, in 2005, we downgraded international diversified funds to a (Weak), which is where their rating has remained prior to this edition. We're also now forecasting a negative return for this category - a first for us.
From best to worst in six years. Well, maybe we sold the emerging market and small cap foreign funds in our model portfolios just a bit too early. Maybe we’re still a little early - we’ll just have to wait and see. Maybe, just maybe, for the first time in fund history, the fund types that investors want the most will beat the market and the other fund categories over the next few years. But we doubt it.
Category Rating: (Least Attractive) - should underperform the market and 80% of the remaining stock fund categories over the next one to three years
Previous Rating: (last change 3/31/05): (Weak) - should underperform the market and 60% of the remaining stock fund categories
Expected 12-month return: -1% (decreased from 1% in our last Favorite Fund Report)
Focus On: International Diversified
(Published 06/01/2007) What's the #1 indicator that a fund category isn't going to perform well? The number of new fund launches in it.
Fund companies launch new funds when they spot an opportunity to make money – not for fund investors, but for themselves, in the form of fees paid by new shareholders. Frequently, the most "saleable" funds are those that have performed well in recent years, enjoyed a significant buzz, and received steady, positive media coverage.
During the final stock bubble years in the late '90's, fund companies launched new tech or growth funds every few days. Back then, brand-new tech funds could bring in hundreds of millions (if not billions) right from the get-go. A classic example was Merrill Lynch Internet Strategies, which launched on March 22, 2000 (within days of the market peak). The launch arrived just in time to bring in over a billion dollars (with a sales load…) before diving nearly 80% in the first year alone.
Today, most new fund launches are ETFs (exchange-traded funds) that run the gamut from countries to currencies and tech to telecom. Many offer access to extremely specialized commodities, currencies, or investment strategies. Traditional open-end mutual funds, on the other hand, are arriving with much less variety. Since December 2006, the majority of new funds are international funds (although some are global). No less than two dozen new international funds have been launched in the wake of that category’s recent sizzling performance. Many investors focus on specific "hot" areas in international markets, like international small cap or real estate investments. There's even a renewed interest in single-country open-end funds.
Apparently, investors aren't anxious about making international investments after they experience great returns. Quite to the contrary, they look for even more focused and risky ways to make their money. We last saw this behavior during the good old tech bubble days, when general tech and growth fund launches in the 90's morphed first into focused Internet funds, then later into new and different types of Internet and telecom funds – remember "b2b" (business to business) "content," and "Internet infrastructure" funds?
Another indicator that we use is fund investor money flow, which analyzes which funds investors are buying and selling. Since fund companies launch funds in sectors where they perceive a demand, it should come as no surprise that investors have been piling into international funds at a record pace. Virtually all new fund dollars are going into foreign funds, even though the U.S. market has been plenty hot itself in recent years. We’re talking tens of billions a month – the sort of numbers that tech and growth funds saw in early 2000.
As contrarian investors, we firmly believe in doing exactly the opposite of what the investing herd does. The more popular a fund category is today, the more likely it is to under-perform tomorrow. That’s why we're downgrading international diversified funds yet again, from a
(Weak) to our lowest rating, a 
(Least Attractive). Back in 2002, we rated international funds a 
(Most Attractive), and they held on until April 2004, when we cut the category down to a 
(Neutral). This category continued to perform well. A year later, in 2005, we downgraded international diversified funds to a 
(Weak), which is where their rating has remained prior to this edition. We're also now forecasting a negative return for this category - a first for us.
From best to worst in six years. Well, maybe we sold the emerging market and small cap foreign funds in our model portfolios just a bit too early. Maybe we’re still a little early - we’ll just have to wait and see. Maybe, just maybe, for the first time in fund history, the fund types that investors want the most will beat the market and the other fund categories over the next few years. But we doubt it.
Category Rating:
(Least Attractive) - should underperform the market and 80% of the remaining stock fund categories over the next one to three years
Previous Rating: (last change 3/31/05):
(Weak) - should underperform the market and 60% of the remaining stock fund categories
Expected 12-month return: -1% (decreased from 1% in our last Favorite Fund Report)