January 18, 2005  Email this  Print this
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Funds in Motion Stay in Motion
by Steven Goldberg  I can still hear my high school physics teacher droning on: "An object in motion tends to stay in motion." Unfortunately, I didn't absorb much physics, but it turns out that this natural law, codified by Isaac Newton, actually works to some degree in the unnatural world of investing. And it can help make you money.
Credit Mark Hulbert, editor of the Hulbert Financial Digest, with most of the work in this area. In almost 25 years of tracking investment newsletters, Hulbert has discovered that many of the best performers use momentum strategies.
Academic studies support the idea that fund managers with "hot hands" tend to stay hot -- at least for a while. A Journal of Finance paper by Mark Carhart found that funds that performed in the top 10% one year tended to perform above average the following year.
That momentum works in investing defies common sense and conventional wisdom, including my own. I almost exclusively invest in funds that I plan to hold for the long run. If I dip into a sector in search of a short-term profit, it's almost always one that is badly out of favor, such as pharmaceuticals have been lately.
Among newsletters that recommend investing in mutual funds, the three top performers over the past ten years all use momentum strategies. NoLoad Fund*X has returned an annualized 19% over the last ten years, Equity Fund Outlook has earned an annualized 18% and All Star Fund Trader has gained an annualized 16%. By contrast, the S&P 500 has returned an annualized 12%.
While each newsletter has its own wrinkles, they essentially follow the same idea. They recommend investing in top-performing funds so long as they remain top performers. When the funds lose their touch, the editors dump them, moving on to whatever's hot at the moment.
In general, they focus on short-term performance -- periods of one year or less. As a practical matter that can mean a fair amount of buying and selling of funds -- which can be accomplished in online brokerage accounts.
None of the newsletters recommends switching so frequently that you run afoul of new market timing regulations. But this is a strategy best done in retirement accounts, where you won't get stuck with a bunch of short-term capital gains.
NoLoad Fund*X has produced the best long-term numbers. Editor Janet Brown bought the letter from Burton Berry in 1997. She divides funds into four categories, from riskiest to most conservative. She suggests that readers invest only from the second-most conservative category. A one-year subscription costs $149.
Equity Fund Outlook, edited by Thurman Smith, is my personal favorite. That's because Smith puts consideration into consistency of returns, and a fund's expense ratio, as well as its short-term returns. A computer maven, Smith's approach strikes me as the most sophisticated of these letters. A one-year subscription is $139.
Ron Rowland, editor of All Star Fund Trader is a former IBM engineer who began by managing his own money, and eventually turned it into a business. He bases his picks on ultra-short-term results. The newsletter costs $199 a year.
Not every investor is right for these newsletters. First, make sure you're managing enough money in a retirement account to make it worth your while. These newsletters sometimes have specials, but none of them are cheap.
It takes a fair amount of time to make the trades these newsletters require. Most important, you have to be willing to stick with a newsletter at least through a market cycle -- say, three to five years. Every approach has periods when it fails, and if you abandon it when it does, you'd have been better off not starting.
Momentum investing won't work in all markets. In a trendless market, in which leadership rotates rapidly, you're likely to do badly. But you can cash in when an investment style or sector stays in vogue for a year or more -- as small-cap value funds have since 2000.
I wrote an article on the momentum approach, featuring these three newsletters, for last March's Kiplinger's Personal Finance Magazine. I just updated the returns from that article, and they're encouraging. In 2004, two of the three newsletters beat the S&P 500. Equity Fund Outlook was best, with a return of 21%. NoLoad Fund*X returned 14%. Only All Star Fund Trader lagged the S&P 500's 11% return, gaining just 8%.
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