Hot mutual funds were often laggards in '08: S&P

On the one-year anniversary this month of the stock market's 12-year low, just about everything looks like a hot investment, which is why investors and financial advisers need to be extra cautious about falling into the trap of chasing performance. Among mutual funds, Standard & Poor's Financial Services LLC found that of the more than 7,400 domestic-equity funds with track records of at least one year, 69% had gained more than 50% over the 12-month period through February. In fact, the average fund in eight out of nine domestic-equity peer groups had 12-month returns of more than 50%. The concern, according to S&P senior equity analyst Todd Rosenbluth, is that investors and advisers will look at these eye-popping gains out of context. “We know people always look at what was hot last year,” he said. But with virtually everything hot over the past 12 months, Mr. Rosenbluth said that the importance of true research is even more significant. “A track record is important, but investors also need to look at things like volatility, the specific stocks in the portfolio, expense ratio and turnover,” he said. “And they need to consider these things not just as an afterthought.” Mr. Rosenbluth found that some of the funds that were big performers last year were also big underperformers in 2008. “When we look closely at some of these recent winners, we find that despite the gains, there are those that have been more volatile than their peers over the past three years and [that] they also invest in stocks of relative unattractive, high-risk companies,” he said. Mr. Rosenbluth gives positive ratings to funds that are allocating to technology, health care and industrial sectors — three sectors that S&P's research team currently favors. He highlights the Fidelity Low-Priced Stock Fund Ticker:(FLPSX) as an example of a fund that is likely to continue to live up to its trailing performance. The fund, offered by Fidelity Investments, gained 67% over the 12-month period through February, “also has a below-average standard deviation and owns stocks that on average are viewed as attractive by S&P,” Mr. Rosenbluth said. By contrast, he singles out the Alger Mid Cap Growth Fund Ticker:(AMGAX), managed by Fred Alger Management Inc., as a strategy that comes with plenty of risk. Although the fund gained 66% over the trailing 12 months, it also declined by 58% in 2008. Red flags, according to Mr. Rosenbluth, are the fund's significant exposure to such below-average-rated stocks such as Lam Research Corp. Ticker:(LRCX) and Micron Technology Inc. Ticker:(MU). The Alger fund outpaced its mid-cap peer group last year but finished in the bottom quartile in 2008, and “on a trailing three-year basis, the fund has relatively high standard deviation,” he said. “We consider volatility a bad thing,” Mr. Rosenbluth said. “Those funds with a high standard deviation give people whiplash.”