Chasing Performance

Know When to Hold ... and When to Fold

New research turns conventional wisdom - a buy-and-hold strategy is best - on its head.

ANY GAMBLER will tell you never fold with a winning hand. And yet all investors know not to buy a fund simply because it has been doing well. That's called chasing performance, and that's bad. We've said it ourselves countless times. The thing is, though, that advice may be wrong.

No, we're not suddenly advocating jumping on any enticing investing bandwagon. But Dan Weiner, founder of AdviserInvestment, which manages $1.1 billion primarily in Vanguard and Fidelity funds, has quietly shared some interesting research positing that strategic buying and selling of top performing funds can beat the market.

Simply purchase the top-performing diversified equity fund (pick domestic or international, but avoid sector funds) in the past 12-month period. Hold it for one year. Sell it and purchase the new No. 1 fund. AdviserInvestment backtested the strategy on Vanguard funds and found it delivered average annual returns of 20 percent over 10 years, compared with an average of 13.7 percent for the Standard & Poor's 500. Jim Lowell of the Fidelity Investor newsletter, came up with similar results based solely on Fidelity funds. Morningstar found the strategy worked best with domestic stock funds showing a 23 percent annualized return over 20 years, handily beating the broad market's 11.6 percent.

The reason for the phenomenon is simple: Trends don't confine themselves to any given 12-month period. Interestingly, some months seem to be stronger than others. Buying the top funds in June or October worked better than buying and selling in February. If the top-performing fund is closed to new investors, go ahead and buy the second best.

So what might work now? Based on our preliminary look, two good options appear be Fidelity International Small Cap Opportunities (FSCOX) and AIM Trimark Endeavor (ATDAX), a midcap fund.

-- Dyan Machan, SmartMoney, May 2007, page 33