CHICAGO – The good news is that the mutual fund stands atop the performance rankings for the first half of 2006. The bad news is that makes it a Stupid Investment of the Week.
It's the one and only rule that this column has had since its inception, the one time each year when the prize for good performance is a cold slap of reality.
If you look at the list of top performers for any short-term period, you will easily find issues destined for a quick reversion to the mean, that have no substance behind the hype of recent numbers or that don't appear capable of maintaining their top-shelf status for longer than a few more months.
Those conditions could be present in Lord Abbett Value Opportunities (LVOAX) , a Stupid Investment of the Week despite being the top midcap value fund for the first half of 2006 with a gain of more than 14.5%.
Stupid Investment of the Week highlights the conditions and characteristics that make a security less than ideal for the average consumer, and is done in the hope that showcasing trouble in one situation will make it easier to spot elsewhere. While obviously not a purchase recommendation, neither is this column intended as an automatic sell signal, as there may be times when dumping a worrisome investment only compounds the problem.
In this case, the Lord Abbett fund is a bit of a reluctant pick, in part because the top-fund-is-a-bad-idea rule has produced mixed results.
The concept is sound: If you buy what has been hot only after a big run, you are late to the party; if the fund's downside volatility is as big as it's positive upside, you could be in for a huge loss when performance returns to Earth.
Apex Mid-Cap Growth (BMCGX) led the pack in June 2003; the tiny fund had more than doubled in six months, overcoming a huge expense ratio. It finished the year with a 165% gain, but has been a big loser ever since; over the last three years, the fund is in the bottom 1% of its asset class, according to Morningstar Inc., with an annualized loss of more than 14%.
In 2004, ProFunds Ultra Wireless Investors (WCPIX) — since rechristened UltraSector Mobile Telecommunications — carried the midyear flag. It finished the year with a 67% gain — helped by a strong fourth quarter — managed a 10%t gain last year, but has dropped more than 7% this year. Over the last 12 months, 97% of the fund's peers have done better, according to Morningstar.
Last year, Guinness Atkinson Global Energy (GAGEX) was the leader in June; it finished the year with a 64% gain that it has followed up with a 7% return so far this year. That puts the fund in the bottom half of its peer group — showcasing how strong energy has been — but hardly puts the fund to shame.
Culling from the top
Hoping to minimize the effects of momentum, the search for the midyear stupid investment eliminated most of funds at the top of the overall list of funds — mostly gold funds and single-country funds investing in China — to consider the top fund in each asset class.
As the top midcap value fund — and with a tilt towards smaller companies just blossoming into midcaps — Lord Abbett Value Opportunities is in the market's sweet spot. Investing in Wall Street's current favorite flavor carries not only the alarming tendency of every hot fund to revert to average performance, but the significant risk that the market's focus is about to shift.
Value Opportunities also is an oddity. Lipper Inc. pegs the fund as midcap value, while Morningstar says it's small-cap value; with midcaps being weaker than small-caps, the fund may have topped the charts by being miscategorized.
The fund is too new to tell; it hit the top of the charts in its first six months, so there is no way of judging whether management can sustain success. The fund isn't just new, it's tiny — just $33 million in assets — and its performance may be a reflection of being nimble; new fund phenomenon — the tendency of new issues to start with a bang — wears off quickly when a fund starts to grow.
"The fund is entirely untested," says Christine Benz, director of fund analysis for Morningstar. "Being small is a positive, and the flexibility is an advantage, but there is an above-average expense ratio to worry about and absolutely no reason to take a flyer simply because it's new and got off to a good start. It could be great management, or just being lucky to be in the right place at the right time."
To its credit, Lord Abbett is not hyping the fund's performance, although there is little doubt that the brokers and advisers who sell the firm's funds will notice and push it on their own.
Their sales pitch will amount to the fund's positives. Value Opportunities is an extension of the firm's successful small-cap fund, which has been near the top of its peer group for the last decade. While not run by the same manager, the fund follows the same style, and it can profit when those small-cap winners grow into midcaps. Lord Abbett also has a history of closing funds before they grow to the point where size drags on performance.
"There's no doubt that we found a market sweet spot and we're getting very good returns out of that right now," says Robert Morris, chief investment officer at Lord Abbett. "We think that the fund's process will deliver some excess returns over time, but people are right to be skeptical.
"No fund can blow away its category at the rate that this one has year-to-date, and do it consistently. If people invest because they read about these first six months and expect that to continue over and over, we'd think they're making a mistake. ... A lot of funds come out of the box with strategies designed to get quick pops from the market, so it's smart to question whether success can be sustained, but we expect this to be in our product line-up forever, and while it may never be the very best fund again, we think it has the potential to be a very good fund."
Copyright (c) 2006 MarketWatch, Inc.