Posts Tagged ‘where to invest’

Nearly a decade ago, David B. Leoper of Wealthcare Capital Management published a well-read paper on asset allocation. In his paper, he argued that diversification alone, which we underline here at the Mutual Fund Site, is not enough to water down the risk attributes of a portfolio. It seemed to me when I first came across his piece that he was either nuts or the concept of asset allocation, which is one of the fundamentals driving all mutual funds, might be widely misunderstood.

Diversification alone is not enough

One of the most striking arguments that Mr. Leoper makes in his paper is that diversification should not be used as a carte blanche excuse to explore higher risk investments within one’s portfolio. And while we have examined some very worthy small cap funds at length recently, Leoper’s point is extremely valid.

Just because you might have the risk tolerance to jump in bed with the RBC Micro Cap fund, it does not necessarily mean you should. Even if you were to limit that exposure to just 5% or even 2%, making an investment like that needs to be done for the right reasons.

And that, the idea of making investment decisions for the right reasons, is really the message we and every other financial planner, consultant, advisor should aim for. And while it sounds hokey, superficial and possibly even contrived, the reason for really getting to know an investment, whether mutual fund, ETF, or individual security makes perfect sense.

Make investment decisions for the right reasons

Ultimately, each investment within your portfolio will relate differently with other securities. It is like having a classroom full of male computer geeks (yep, I would be there!) and then adding an aggressive female athlete into the mix. All of a sudden, the dynamic changes. Some students might compete for the female’s attention, others might take a more aggressive position when it comes to their projects, etc.. Either way, the classroom would change, maybe dramatically or maybe subtly, but definitely it will change. And with time, that change may have a positive or negative impact; either way, there will also be an impact.

To invest for the right reasons, investors will want to understand how the new, added investment will change the portfolio’s dynamics. This might involve simply aligning the investment with other asset classes and sub-classes or it can involve something as complicated as R-Squared.

More importantly (and a lot simpler), the new investment should make sense with the portfolio’s overall objective. For example, if one wants long term growth, choosing an investment that focuses on speculative technologies might not make much sense. As well, this sub category may not correlate well with other asset classes within the portfolio.

By taking a closer look at one’s portfolio, it can be fairly easily ascertained whether a new investment will make much sense at all. Of course, for investors who are die hard mutual fund investors, the concept of diversification is an easy one to understand and appreciate. But that alone does not give free reign to buy assets that add no value, either tangibly in terms of risk-adjusted returns or intangibly in terms of how well such an investment compliments the balance of the portfolio.

The idea that one mutual fund company can be better than another is not a new one. Because so many investors remain on edge after the market “correction” that took place in the last few years, deciding to jump in bed with a small cap fund is even more difficult than normal. And small cap funds, as we have discussed elsewhere on this site, are really not all that risky in terms of their long-term performance track records. So just imagine how people with the right risk tolerance might feel about investing in other types of mutual funds; likewise, how low risk investors will feel about Balanced Funds or Income funds.

Can Big Fund Companies Eliminate Risk?

While large mutual fund companies will have more assets under management than smaller companies, it does not necessarily mean they will eliminate risk better than small fund companies. This statement is supported by the following:

• it can be argued that smaller fund companies (based on assets under management) have “more” to lose than larger companies and will therefore take a more conservative approach to security selection.
• large mutual fund companies might have better access to top talent, but like all big companies they will be more heavily focused on their own bottom line profitability. This can translate in underpaying their talent or working with less progressive and astute analysts and managers.
• large mutual fund companies are often able to offer better incentives to the sales force; smaller companies will be restricted by their budgets.
• at the end of the day, both large and small companies worry about beating the index and their peers. Failure to do so will often result in cash outflows. Therefore, smaller mutual fund companies will be more sensitive and therefore more intent on making the right investment decisions.

So does it make sense to choose a Fidelity mutual fund over, say, an Adirondack fund?

Tough to say. The best performing Fidelity small cap value fund (which is unrated by Morningstar.com) actually under-performs against the top performing Adirondack small cap fund. Both funds have the same risk profile.

However, many people will find things with each fund that either works or does not work for them. Which makes the argument that choosing the best fund for your portfolio should really boil down to how well the fund, its management and performance compliment your own asset management strategy. Taken one step farther, the best mutual companies will be two different companies for two different investors. And, of course, this is why it is impossible to say, one way or another, whether bigger mutual fund companies are better or worse than smaller mutual fund companies.

It is about that time again where the Mutual Fund Site stresses the importance of asset allocation. This has very little to do with the recent market turbulence that has seen volatility (as measured by the VIX) jump to the highest levels of the year and more about how asset allocation accounts for more than 90% of one’s long-term performance track record. Regardless of whether mutual funds, exchange traded funds or any other asset management system are part of one’s investment strategy, asset mix is clearly important.

What else influences long term performance in an investment?

Other factors that influence a portfolio’s long term returns are asset selection, market timing and other factors (such as dollar cost averaging, expense ratios and so forth). But as shown here, none of those factors account for more than 5% of returns.

And here is why: the above factors involve investor intervention whereas asset allocation does not. An investor must consciously decide when to buy and sell (market timing), what assets to include (asset selection) yet asset allocation does not involve decision making.

Asset mix can be determined through a series of a questions like the handful of questions we ask on our Asset Allocation Model Builder. All the investor needs to do is stick to the asset mix recommended. Plain and simple; no emotion-driven investment decisions required unless it is for rebalancing or making higher level changes to the asset mix itself.

This is supported by the simple fact that many fund managers are better managers with their portfolios than we are with our own: we have an emotional investment in our savings whereas fund managers do not. Emotions cloud the logic that one needs in order to be a successful investor.

At more than 90% of a portfolio’s long-term returns, it is therefore well worth taking the time to review one’s asset allocation and making the appropriate changes to one’s investment portfolio. This is a no brainer, really.

It is not easy to find mutual funds that have earned double-digit returns on a year-to-date basis. But it seems that this small cap fund has done just that, earning 12.5% since January 2, 2010 even though its investment strategy might seems a little, well, unique compared to others in its category. But before we dig into three of its top 10 holdings, here is a small review of the ING Small Cap Opportunities Fund (NSPAX).

The ING Small Cap Opportunities A fund is a Small Cap Growth Fund with a great track record.

With just $109,500,000 under management, the ING Small Cap Opportunities fund has outperformed its category in 4 of the past 5 years, including its YTD returns. This coincides with Steve Salonek’s arrival on the fund in 2005, suggesting that the change in management at that time was a profitable change for ING.

In addition, this fund ranks in the Top Quartile for its YTD, 1, 3, and 5 year performance track record, another great achievement given how broad a category this is. Currently, Morningstar ranks this fund as having AVERAGE risk, and it has held this rating since Morningstar has started rating this fund. Currently, it has a risk-adjusted rating on this fund of just 3-stars, even though the fund has consistently held 4-star ratings in all periods except for its 10-year period where it held a 2-star rating, and its overall rating is, again, 3-stars.

On paper, this small cap mutual fund does not look all that inviting. But let’s take a closer look at its holdings. At the Mutual Fund Site we believe that the underlying portfolio of any mutual fund should motivate an investor into taking a long-term investment position, a short-term position, or no position at all. This highlights, therefore, the importance of portfolio, and in the case of the ING Small Cap Opportunities fund, the portfolio has a fairly aggressive (+18%) position in the Healthcare sector. Its next closest sector is the Software sector at 11.56% and third up is the Consumer Services Sector at 11.35%.

While Healthcare will certainly see its day, we believe it could be a little premature at this point to be so heavily invested in that sector when there are others that stand to see a quick, solid rebound with favorable economic news.

As a fund of just 145 underlying securities, this small cap mutual fund places relatively low importance on its top 10 holdings — which make up just a little more than 12% of the total holdings. In fact, its largest overall holding is a money market fund, and aside from that its first Healthcare security (at 1.28% of assets) is number 5 on the Top 10 list. At any rate, let’s take a look at 3 of its top 10…

1. Solera Holdings (1.47%). This company provides software and services to the insurance industry, assisting with the claims process. Overall, this industry is a growth industry given the increasing number of claims that insurers face on an annual basis — not including recent increases in fraudulent claims on account of the recession. With strong, consistent earnings growth over the past 3 years, it comes as little surprise that analysts polled by Thompson/First Call rate this stock as a strong buy.

2. Bally Technology (1.44%). Bally provides gaming machines and solutions for casinos. Although the company has seen a slight bounce in revenues since its 2007/8 levels, its Q1 levels are below 2009 Q1. We have commented elsewhere on whether gaming stocks are a good idea in our review of the Buffalo Micro Cap fund and the bottom line is that they should probably be avoided until economic data supports people spending and wasting money on this type of entertainment. We will elaborate here and warn investors that Bally Technology could be a long-term investment for this fund, a view that seems supported by the analysts at Yahoo!, this “HOLD” stock.

3. Gymboree Corporation (1.14%). As a children’s retailer, Gymboree operates over 620 retail stores in North America, competing with companies like GAP, Carters and the Children’s Store. This is some pretty stiff competition, yet Gymboree has weathered the economic storm extremely well. The company is very well managed, having achieved revenue growth over the past three years when so many others have suffered in this segment. Ultimately, we like Gymboree for its innovative branding and revenue growth in such tough periods. The biggest threats, which have been well documented, is the ease of entry into this segment from newcomers that may be able to offer similar product at a fraction of the price, not to mention alternate retailers who offer similar product — such as Wal-Mart.

Overall, the ING Small Cap Opportunities fund may be a small cap mutual fund that many people would be nervous about owning. However, with its AVERAGE risk rating and ABOVE AVERAGE returns, the fund has a well balanced portfolio in terms of risk diversification, as evidenced by its low concentration in its Top 10 holdings, the small/low percentage of total assets of its top 10, as well as its strong diversification (despite healthcare, as a whole representing nearly 1/5 of total holdings).

At the Mutual Fund Site, we like this small cap mutual fund and believe it would recommend it for investors who need a relatively neutral holding with smart investment management and good diversification.

There is a difference between investing in China and investing in China’s growth. This is a careful distinction that a lot of investors fail to make, yet it is a necessary one if one is seeking to profit from the undeniable growth that the Chinese people are expected to enjoy in the years to come.

Investing in China

The act of investing in China is the same as investing in domestic companies. The process involves narrowing down a large field of potential companies and ideas to a handful of prospects and then digging even deeper to determine whether that company meets fundamental basics to earn your investment.

These fundamentals would include such things as an appropriate equity level, satisfactory growth rates, margins and so on. The key difference is that such companies are actually based in China, so our everyday experience with them would be virtually non-existent (compared to investing in, say Wal-Mart or Ford or Apple, etc.).

Another key disadvantage to investing in foreign companies is that most people are unfamiliar with their political alliances, which becomes increasingly important in countries like China. To make an investment in a Chinese company, one should understand their political standing and how that bodes for their future growth and sustenance.

Investing in China’s Growth

In contrast to the above, investing in China’s growth is quite different. This involves taking positions in domestic companies that have the potential to profit from China’s growth. For example, companies that outsource key manufacturing processes would fall into this category. Such companies will be able to reduce their cost of goods sold (manufacturing costs) since labor in China is at a discount to domestic labor.

Another example would involve companies that are positioned to enjoy part of the expected growth in the middle class. This class historically creates a deeper demand for certain products and services, such as discretionary and luxury goods. Companies that have been allowed to establish a presence in China obviously stand to benefit from this and could offer great investment potential as well.

Summary

It is unquestionable that China is set to enjoy an aggressive growth rate in the years to come. Positioning one’s portfolio to take advantage of this growth is a little more complicated — does one invest directly in companies that have little relevance domestically and operate in a foreign political climate, or does one invest domestically in companies that have taken the steps necessary to enjoy part of this aggressive growth?

As often happens, the question becomes one of risk tolerance and investment knowledge. Knowing that there is a difference between the two surely helps.

There should be little surprise that so many investors are interested in learning more about China Mutual Funds. While the Mutual Fund Site has only spoken about China in a round-about reference to one of the world’s greatest portfolio managers (Anthony Bolton), it makes some sense to review some of the risks associated with an Investment Strategy that is so bullish on China as well as some of the potential rewards. But if we were asked where to invest in China, we would probably take a really long time to respond to such a question. The reason will reveal itself below.

It is generally well known and accepted that China represents a tremendous investment opportunity. For most investors, however, that means investing in China in order to sell one’s product or, less likely, services to the Chinese population. Think of General Motors, for example. They own Cadillac and, with a growing middle class in China the demand for discretionary luxury goods like Cadillacs will increase. The growing middle class is not a reason for General Motors to go and purchase or invest heavily in one of the nearly one hundred manufacturers. With this in mind, investors should be cautious about whether they want to invest in Chinese companies or invest in domestic (US) companies that are well positioned to profit from China’s rapid development.

It goes without saying that China continues to censor and control much of the local industries. Recently, Google pulled out of China as a result of this (it can be speculated that Google became frustrated with China’s insistence that Google operate in a manner satisfactory to the China government). Luckily, Google had the resources to call it quits; other companies might have been forced to alter their business model and integrity and comply for financial reasons. Given Google’s frustration, it should be seen as rather risky to invest directly in China.

In terms of China Mutual Funds, there are but three that Morningstar considers 5-star. One of them, the Templeton China World Fund has returned nothing (okay, it returned -0.17% as at April 19, 2010) and still manages to outpferform its peers. AllianceBernstein’s Great China ‘97 has performed similarly and is currently ranked as a 2-star fund. Clearly, even the professionals are having difficulty finding the right securities to invest in. And when highly regarded professionals like those running these two very similar (yet greatly diverse by Morningstar rating) funds, then it goes almost without saying that individual investors will have a tough time making money in China Mutual funds.

On the positive side, China growth translates into a hunger for many of the resources found domestically. This results in a strong demand from one of the world’s largest populations and potentially soon-to-be wealthiest nations. This was evidenced when China recently announced a multi-billion dollar investment Venezuela in exchange for future delivery of oil.  Such an investment suggests that perhaps it would be more wise to invest in some of Venezuela’s larger oil companies and not China itself. As well, both funds listed here returned more than 40% for their 1-year performance. Obviously, there was some growth to be had.

Perhaps the popularity of China mutual funds is just that — popularity. And when we think back to high school, not all of the popular kids were among our best friends. Maybe the same holds true for investing there. Maybe it is smarter to invest in less popular areas and enjoy the future growth potential that comes with a contrarian approach.

It appears that a lot of people who find the Mutual Fund Site are looking for help with investing $10,000. Although we cannot “tell” people how to invest 10,000 dollars, we can certainly help them along in their investment journey, whether through our Free Asset Allocation Model service or our specific fund recommendations like our Small Cap Fund Top Pick for 2010 and our High Yield Investment Top Pick for 2010.

Ultimately, figuring out how to invest $10,000 (why 10K and not 20K or 50K, I don’t know) wisely will involve a lot more than visiting just this site. It will involve spending some time at Morningstar and sifting through the data there, particularly when it comes to your core holdings. It could also involve spending time at Fundalarm, a website that “warns” people about the fund they have invested in or are considering investing in. But first things first:

Start with your Asset Allocation Model

Knowing what your asset mix should look like will obviously provide a great starting point for all investors. Whether you are a Balanced investor, a Growth Focused investor or even an Income investor will tell you just how much money you should be “risking” in any given asset class, starting with Cash, then moving on up to Income and then finally Growth, with the risk levels increasing correspondingly. And then, if your risk tolerance allows it, consider specialty funds.

In fact. our Top Picks for 2010 are both specialty funds — the High Yield fund is not considered a core fixed income holding by any stretch (even though it offers a below average risk profile, it is still focused enough to fall outside the mainstream) and evidently our Small Cap Value fund is nowhere near being part of the main “Growth” class (even though it is consider low risk among its peers).

Once you have your asset allocation model figured out, you can further drill down and see how much of your $10,000 can be invested in the types of investments we look at fairly regularly. But keep in mind that the bulk of that investment should be in core holdings — a fixed income component, a growth component as well as (usually) a small cash component.

So, to get started simply click on the link titled “Asset Allocation Model Recommendation” as shown below:

Withing a couple of days, we will have your Free report to you so you can get started to see just how much of your $10,000 can be invested in which asset class and, of course, how much can go into those terrific specialty funds (whether they are the ones we recommend or not) that have the potential to improve your portfolio’s performance tremendously.

Best of luck and we hope to see you back again soon!

A little more than 3 months ago, the Mutual Fund Site provided a couple of firm recommendations on where mutual funds investors should invest their money. As far as we were concerned, these were exactly where to invest, even though our gut told us at the time that then-current market conditions made such a task rather difficult.

Those two funds were the Janus High Yield Fund as part of our Income Class recommendation and the Ivy Small Cap Value Fund as part of our Growth Asset Class.

To date, the Janus High Yield Fund has returned 4.37% YTD, a reasonably good return given all of the speculation and doubt surrounding the Income asset class these days. Are we satisfied with this return? With the performance?

Yes, indeed we are. The fund remains under the management of Gibson Smith and has stuck to its mandate. It remains invested primarily in mid-term, below investment-grade bonds (the average yield is a touch over 10%) and, well, provides investors with a positive rate of return. This is no easy task since, as we all expected, interest rates are on the move.

Our other fund, the Ivy Small Cap Value Fund, has returned 13.39% YTD. Some of the reasons this fund has performed so well could have something to do with Ivy’s overweightedness in financial services. However, we are not overly concerned that this fund is at risk the way most individual investors and some other funds are. The reason is simple: Ivy has invested in medium and small cap financial services firms. Dividend yield are strong (they would make GE and other financial firms look cheaper and greedier than they are) and many of the underlying assets have yet to enjoy the gains that the rest of the sector has thoroughly enjoyed recently.

Would we change anything?

No, not at this point. Both funds remain healthily below average in terms of the risk profiles versus their peers. And both have returned more to investor than anyone else would have expected at the start of the year (we even found some interesting trash talk on another, nameless website). Which bring us to the rest of the year…

We expect the Janus fund to handle the obstacles ahead with relative ease. They have performed well to date, but the challenges will keep Gibson busy.

We also believe that the Ivy Small Cap Value fund will face challenges, particularly when so many individual investors who have poured their money into these big bank stocks realize that the fundamentals are not there to support those price run-ups. However, the fact remains that the companies in which the Ivy fund has invested remain profitable and well capitalized with continued improvements to their equity positions through retained earnings. Overall, both funds are not only where to invest your money, but will continue to see some strong returns throughout the year.

When we look at the recent popularity of bank stocks, it is evident that a lot of people will get burned. The recent run up has resulted in higher volatility, which means that just as quickly as things have risen, they will drop. And up until the point that the prices really start to head south, someone will keep buying up these “popular” bank stocks. Everyone except the mutual funds who, for the most part, know better that to get sucked into the popular investment strategy when things rise, they will only keep rising.

Taking a contrarian investment approach like those we discussed elsewhere on this site might help.

Or it might not. After all, financial services firms remain relatively unpopular unless we are talking specifically about the “big banks,” the same stocks and companies that burned people in the past. But not all financial services firms are created equally. People who want to know where to invest their money might do well to examine the smaller firms, like those where Ivy Small Cap Value fund invests.

After all, our recommended Ivy Small Cap Value Fund has rewarded investors with a 13.39% return YTD.

Evidently, the folks at Ivy are doing something right, yet in their top 25 holdings you will not find any Citigroup, AIG, Fannie/Freddie, et al. holdings. Not a single one of them. In fact, they invest a large chunk of their assets in Small-cap stocks… not large, not Giant. (To a lesser extent, they invest in Medium cap securities, but as a small cap focused fund, they are pretty keen on sticking to their small-cap guns.

Given that less than 4 months of the year have passed, a 13.39% return (as at April 9, 2010) is pretty respectable. They know where to invest, no doubt about that, especially when it comes to investing in financial services firms. So, for those investors who have enjoyed the volatility rise and continue to pour money into some of these unsupported (fundamentally anyway) financial services firms, don’t let yourself get burned. Invest in a mutual fund that pays the pros to put your money where it belongs — in the right firms.

As a follow up to our former Contrarian Investment Practices post, we want to take a closer peek at exactly where to invest if these contrarian theories have any merit. Of course, we will look at mutual funds specifically.

In a recent article published by Russel Kinnel, the Director of Mutual Fund Research over at Morningstar.com, it became quite apparent that Contrarian Investment practices actually do work. The methodology that Kinnel used involved investing in funds that were seeing cash outflows (the “unloved” funds) rather than those funds that were deemed most popular based on the dollar amounts of inflows (the “loved” funds).

What Kinnel discovered was that investing in the unloved funds yield returns that were better than not only the “loved” funds returned, but the S&P 500 as well. In some cases, those “unloved” returns were substantially higher — 8.1% for 3 years versus the “loved” returns of 6.24% and the S&P returns of 6.96%.

The same trend holds for a five-year period as well, with the “unloved” mutual funds outperforming (8.08%) both the loved funds (4.25%) and the S&P 500 (5.76%).

The Question becomes one about finding out what the “unloved” are.

Finding out what the unloved funds are poses something more of a challenge. Kind as he is, Kinnel pointed out in his article that the “unloved” funds or categories were the large-cap growth, large-cap value as well as world stock. Easy enough to find the top performers in these categories; simply visit Morningstar.com and use their free fund screener.

But what about those times when finding these unloved categories is more difficult than finding them in an article so kindly published by someone like Kinnel? Well, let’s take a look at Kinnel’s statistics once again. In terms of best performing mutual funds, the following trend emerges quite easily:

• Unloved categories will outperform the Loved categories
• The S&P 500 will outperform the Loved categories, but not the Unloved categories.
• The Loved categories will not outperform either the Loved categories or the S&P 500.

So, if you cannot figure out what the “unloved” funds are (or even what the “loved” funds are for that matter, meaning you can’t figure out what to sell), there is one option. Consider that the S&P 500 outperforms exactly what your friends buying and likely what the advisors are recommending… why not buy Index Funds?

Index Funds might not beat out the top Unloved categories as a whole, but will definitely outperform what your advisor is recommending (or even what your friends are buying). This is particularly convenient if contrarian investing is something that investors are unable to fully agree with (e.g. cannot stomach being possibly wrong with their contrarian choices as they fluctuate and fail to return a positive number for a couple of years). While this is not the absolute best way to achieve the best returns, it definitely is where to invest if you do not want the hassle and potential expense associated with learning about mutual fund inflows and outflows.

An interesting philosophy exists, whether you invest in mutual funds or straight equities, that suggests we can all know where to invest if we go against the current rather than with it. In other words, if we adopt a contrarian mentality, we stand see some sold long-term gains in our portfolios. As an investment strategy, this is not always an easy thing to do. When you get into picking the best mutual funds, it becomes even tougher. (And of course if we are short-term traders, then it becomes virtually impossible).

So, where to invest…

Common sense and history tell us that if we all invest in a single asset, we drive the price of that asset up. Look at Oil in 2007. Look at Gold today. Look Apple shares. But the risk you run when you follow the herd is that you end up buying that asset somewhere near the peak of its price range, exposing your portfolio and investment to some serious and very real risks. For these reasons, we often try to find that diamond in the rough, that undiscovered security that is trading at a terribly low valuation — look at RIMM seven years ago, for instance, Teck Resources (TCK) even 1 year ago. Again, with the power of hindsight, we would all be retired by now, and we would all be millionaires.

With this “find the diamond in the rough” mentality, a couple of things can happen. One, we take on exaggerated risks because the assets we buy are simply cheap; they lack the fundamentals to support investing in them at all. The second thing that happens is that we hit a grand slam, we pick the right security at the right time when everyone else threw money at the latest and greatest Wall Street gem. The latter, of course, is an example of Contrarianism and this is exactly how we should invest, according to some.

What is Contrarianism?

This type of investment practice can mean a different things for different investors. The obvious interpretation is to sell when and what others are buying, and vice versa. It speaks to Warren Buffett’s famous quote: “Sell when others are greedy and buy when others are fearful” (not an exact quote, but the message is bang-on).

On a deeper level, it involves going in areas that others are ignoring. It means buying Citigroup (C) when it was trading at $1.02 and everyone else was not only ignoring it, but buying bonds at ridiculously low rates. It also means believing in the company’s fundamentals, trusting that the Board is doing the right thing by appointing Vikram Pandit after Charles Prince resigned (of course, each company will be different, the names will change but, in Bon Jovi’s words, the streets are the same).

It is in my opinion that this second type of Contrarian investment practice is the one we want to adopt as amateur, novice and even intermediate investors. Not only is it less risky (e.g. ignoring a strong asset class altogether and dumping money into unfavored classes even when fundamentals do not support it), but we can actually apply this practice to mutual funds purchases.

Now, understand that great websites like Morningstar have built tremendous intellectual capital, websites, and businesses doing exactly the opposite. That is to say that their models often favor top-performing funds where regular investors are flocking (this website’s Top Picks are great funds that Morningstar has ranked well, also). And other sites like FundAlarm also takes this view, ranking funds as “dangerous” if they fail to meet or exceed their group or category for three measurement periods.

But Contrarianism takes a different view. Often, the mutual funds you should invest in under this theory are those with net redemption figures, which are often triggered by poor performance track records that gets noticed by those two websites mentioned in the previous paragraph. Some Small Cap Funds like the Ivy fund (YTD return of 9.74%) we like, for example, invest heavily in small to medium cap financial services firms. Investing in this Ivy fund could certainly be considered a contrarian move; investing, on the other hand in the High Yield Investment fund that we recommend (YTD return of 3.80%), would not have been.

While both funds above are in completely different asset classes, they have both outperformed their peers, which leads to a natural question: do Contrarian Investment Practices really work?

The simple answer is: yes they do, especially with mutual funds.

(More to follow… check back soon as we take a deeper look into this interesting investment strategy and provide a tangible foundation to our argument).

In an article published at Bloomberg.com on March 18, 2010, it was noted that bonds issued by financial services firms like JP Morgan and Credit Suisse in particular came with rates that were substantially higher than rates in the general market. What this means for mutual funds and growth funds in particular is that there is plenty of opportunity in the financial services sector. Let’s take a closer look.

The Bloomberg article in questions makes it quite clear that the debt sold by banks, brokers and insurers returned 0.81% compared to the broader market’s return of 0.48%. This is a premium of more than 80% over what the broader market dictates. Consider this for a minute as we explore another interesting comment that was made in the article in question.

Brian Machan, a money manager at Aviva was quoted as saying that very few people are “underweight” in financials. This means that mutual funds are heavily buying up this debt. They are doing it because it looks attractive. The reason it might look attractive is that the yield is expected to drop, thereby increasing the value of those bonds on the open market.

The flip-side is that the financial services firms issuing this debt find rates attractive. This means they expect rates to increase in the future, allowing them to finance debt at today’s currently low rates. All indications support a rising interest rate environment; if ever there was a time to issue corporate debt now be that time (to the benefit of the borrower, that is).

Now, getting back to the premium paid by these financial services firms. Consider why they might need to raise this type of capital. It is cheap. Plus it helps finance a whole lot of plans. These banks have something up their sleeve and it is just around the corner by the look of things.

As far as growth funds are concerned, the mutual funds that are bullish on financial services such as the Ivy Small Cap fund we wrote about already or the Dryden fund we bragged about earlier, send a strong message to the investment community: financial services stocks are expected to outperform. This sure seems to be supported by the level of debt they are confidently raising right about now.

Other growth funds that invest heavily in financial services stocks include the FBR Small Cap Financial fund which has a history of LOW risk and above average returns. Morningstar rates it as a 5-star fund! Like the Ivy Small Cap fund that we touted as our Top Small Cap Pick for 2010, the FBR fund has a large interest in Iberiabank and East West Bancorp, regional banks that stand to substantially benefit from a positive shift in the economy.

Regardless of what type of mutual fund you choose, ensure that your growth funds have at least some exposure to the financial services sector. Whether they are smaller, regional financial companies like those held in the IVY or FBR mutual funds or larger banks like JP Morgan and Credit Suisse, the indications are quite clear that these firms expect to reap the profits and rewards of an economic turnaround that is just waiting to happen.

It may seems obvious to some and it is definitely obvious once it is pointed out to investors, but where to invest in periods of economic expansion is definitely not in typical bond portfolios. Instead, value funds or mutual funds with a good blend of value and growth securities would be the most logical place to start. As an investment strategy, this is not an art or a learned skill; it simply makes sense once the description of an economic expansion is properly understood.

So what is an economic expansion?

According to Smart Money, which published a great article about the Yield Curve, and economic expansion typically occurs immediately after a recession. Now, we have to be careful about how we define a recession. Yes, it means for tough economic times and periods of cutting back and sacrifices. But economically, a recession is different than what people like you and I experience. Instead, a recession is categories by certain economic statistics, including among other things, several periods of consecutive negative growth. Once that trend is broken and other economic statistics line up, that recession is over. And strange things start to happen.

Like what?

For starters, yields on treasuries and bonds steepen. This means that the rate on a 3 month treasury bill more than 3% lower than the rate charged on a 30-year treasury bond. As of today (March 15, 2010, that spread is more like 4.47%), this certainly holds true according to data on bloomberg.com. And if the Yield Curve is at all accurate in everything it has suggested since the late 1970’s, then we are in a period where the economy is expected to start growing quickly in the near future.

What does that tell us about where to invest!

Before we get to that, consider what it tells us about where not to invest. Obviously, when rates are expected to increase (everything we hear today combined with the yield curve tell us as much), bonds are out of the question. This means lightening up on income-class securities and moving money into equity based securities.

But does that mean growth funds or value funds (or a blend of both).

At the Mutual Fund Site, we have suggested that some small cap funds are actually no brainers. We outline the reasons why in some detail, but let’s look at the most fundamental reasons why some small caps are a good starting point:

• Value. Yes, we said it. Small caps offer tremendous value right now. Why? Because they were beaten down the credit crisis of 2007 dragged through 2008 and into 2009. The fear was that small cap stocks would disappear off the face of the earth once they could not fund their operations through credit or they went broke trying to make payments on higher-rate capital. In many cases, this did not happen and the survivors stand to benefit. In our case, we like regional financial institutions because they have government stimulus and people’s returning to work (okay, in some cases where employment is over 20% like in some areas of California, this seems like a stretch, but things will improve even in these highly unemployed areas) on their side. Plus, many of these companies have been very profitable during the last few years… even with the world crumbling around them!
• Small caps are one of the first segments to record steeper profit growth. This could be a numbers game in some cases, but it could also be the result of smaller companies willing to take the risks that larger corporations are unable to take. Blame it on smaller boards, less restrictive financial covenants, etc., but smaller cap companies take risks where larger companies simply will not… and this often bodes well for them.
• Lastly, small cap securities are one of the first to experience a “pop” in security price when recessions are over. Look at Citigroup as an obvious example (although you cannot say they are small cap, their story is quite well known). When it became clear that they would survive after all, its share price popped on the news alone. All they had to say was they were going to survive! Imagine a company that had numbers to back this up! Small caps have those numbers.

Does that mean we recommend small cap stocks? If small cap stocks are where to invest, what does that say about less risky alternatives?

Well, we believe that value funds are where to invest. Because even larger cap securities (and many mutual funds hold them) offer tremendous value, even in today’s market. And this is where investors should be — in value funds or funds that invest in such securities. Is it too late? No, not if we believe what the yield curve is telling us. I mean, look at GE, one of the world’s largest and most-diversified conglomerates. In 2008, its stock price touched below $6.00. Talk about extreme value… now it trade at nearly $16 and it still has inherent value.

Of course, we advise clients to be careful when they look at value funds and make sure they are investing in something that meets their investment needs and risk tolerance.

When we have so many mutual funds to choose from, we often get lost in some of the irrelevant details. We seem to want to chase the next trend, the biggest or hottest sectors and so on. Bond funds, value funds, dividend funds; we talk about these specific investments right here on our site just as planner do with their clients. If we were looking at economic figures, we would call it micro-economics. But when it comes to investments and mutual funds in particular, taking a macro-economic approach might actually help tell us about where investors should steer their money.

If we look globally, for example, we see that the Japanese Yen has been taking a hit over the last week or so because of that country’s position on interest rates. Unlike the US where the economy is (finally) starting to grow and rates have increased (Fed Funds Rate) and are expected to continue to increase, Japan is looking to reduce rates so that people will borrow and therefore buy more. While this fiscal policy will devalue their currency, the implications for Japanese corporations, particularly those that export their goods, are actually very positive.

In fact, a devaluation in currency combined with increased foreign spending will have a turbocharging effect on Japanese companies that report their financial results in Yen. Not only will sales revenue increase, but if foreign dollars are being used to purchase goods, the currency conversion results in a forex gain on the financial statements.

This could be a bad thing in the long-term. As the Yen stabilizes and starts gaining in value again, the company may have forex losses which can offset or more-than-offset stable or even climbing revenues.

What this means for mutual fund investors that is that Japanese-heavy value mutual funds might be a safe bet for shorter-term gains. Why? Because the premise of a value mutual fund is that the securities held within the portfolio are undervalued. This can be based on any number of criteria, but are normally price-to-earnings, price-to-book (value), price-to-cash and so on and so forth. Ultimately, the fund manager will determine whether to include a security in his or her value fund, but the qualifying criteria will come down to one thing: the security is underpriced.

This security, mind you, can be equity or income based. Right now, investors would gain either way. Japanese bonds can very easily increase in value if rates start dropping. Japanese equities can also increase, but it could take more time before revenues start to increase and translate in to balance sheet strength.

Our next step is pick a value mutual fund that meets our specific investment objectives (with time and risk as the driving force behind such a decision).

Now this is a top-down investment approach. It is how the Mutual Fund Site comes across mutual fund recommendations. A financial planner and/or investment advisor will work this way as well. Except they do this by also understanding your goals and matching up your goals and beliefs as best as they can to the macro-economic situation.

A long-term investors who has a decent appetite for risk will be ill-served to keep all of his or her investments in domestic securities. It normally “fits” to incorporate foreign or global investments into the plan. It never (or it should never) involve finding a value fund and then justifying a reason why it makes sense.

With that in mind, buying any kind of mutual fund because of a recommendation is often the wrong approach. Taking a bottom-down, birds-eye approach to your investments always makes more sense.

As one of the BRIC nations (Brazil, Russia, India and China), China represents a huge opportunity for investors with nerves of steel and a risk tolerance that most people would love to have (particularly when it comes to alpha-male poker tourneys). When it comes to mutual funds, legendary manager Anthony Bolton has come out of retirement specifically to head up a brand new, China-based mutual fund for one of the leading fund companies in the world – Fidelity. So what does that tells us regular folks about the merits of China insofar as growth funds are concerned?

For starters, it confirms the global opinion that China certainly presents a huge investment opportunity. This is not simply a North American view (Bolton is, or was, based out of the UK and his track record from 1997 to 2007 with Fidelity’s Special Situations Fund speaks for itself). But investment field aside, all industries are a little nervous about China. Why? Because of what will happen as their economy grows.

See, as China’s economy continues to grow, the financial demographics of their population will shift. There will be a growing middle class, regardless of what naysayers might preach about the socialist possibilities of their government. There is already evidence of this as Chinese workers outsource their skills to the world through the internet and other legitimate venues. In addition, China is one of the world’s largest student’s of the English language. It is estimated by People Stream that as China becomes the world’s largest English-speaking nation, the market will increase by 300 million possible employees. Even at 1/2 of the salary (this is being generous) of North American employees, Chinese candidates present a huge cost savings for companies that need English-speaking individuals. (You can view their 5-minute YouTube presentation here). For the Chinese, this translates into a growing middle class with growing middle class wants and vices. Even if the naysayers are right and a “socialist” government controls Chinese markets when they cannot control the inflow of wealth, they may be able to control where that wealth is spent. Regardless of whether there is much control, a lot of that wealth will be spent in China, allowing Chinese companies to see a long road of prosperity ahead of them. And that is as of today! Not five years from now, but right now.

Some of the risks to investing in China are well-known already. They include poor transparency in terms of environmental controls. Poor transparency in terms of financial reporting. They include a currency that the government will not allow to fluctuate on the free market (it is pegged to another currency, the US dollar). These are all risks; an investor might find a great Chinese company one day only to find that it has not made a dime or was bankrupt or presented inaccurate financial records or was penalized for not having the right government contracts and so on and so forth. In other words, it could be gone within a matter of days… These are real risks with investment in China.

By holding a growth fund with a China focus, investors would hope that the mutual fund manager has done his or her due diligence. Some funds, however, will not do this properly, they will not visit the company or do more than analyze the figures. There could be more risk with funds with low assets under management than larger funds with enough of a capital base to fund such trips to China. The bottom line is that investors should approach these types of investments with a great deal of caution. They should understand the thinking behind the fund itself and should be comfortable with the management team. With such things out of the way, investors looking to enjoy long-term growth will surely be rewarded.