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Mutual Funds

In Praise of Big Mo

To find a winning momentum fund, look for one with modest assets, a competitive edge and low costs.

In case you missed it, momentum funds made a great comeback in 2007, although they quickly gave back some of those gains in early 2008. Maybe you missed the rally because you were among the folks who swore off momentum funds when they were slammed in the 2000-02 bear market.

Academic support. Momentum investors buy stocks that have already gone up, betting that they'll go up even more. As a strategy, this seems like mindlessly chasing the hottest thing. But there are actually sound academic underpinnings to the practice. Behavioral-finance studies show that investors tend to underestimate the magnitude of change. So investors often don't anticipate that more good news (or more bad news) is on the way because they fail to recognize how much has changed.

Now take that idea, unleash a thousand PhDs trying to figure out the best way to profit from it, and you get a thousand variations on momentum. You can track stock-price momentum, earnings momentum, earnings-versus-analyst-estimates momentum, analyst-earnings-estimate-revision momentum and so on. You can back-test your system to see how well it would have worked -- even though you know it won't work that way in the future because bunches of other smart PhDs have noticed the same thing and will drive up the price of the same stocks you're trying to buy. You can also attach a momentum model to another model, such as one that forbids buying a stock above a certain price-earnings ratio.

Momentum investing is an aggressive strategy that produces fast gains and fast losses. To find a winning momentum fund, look for one with modest assets, a competitive edge and low costs. These are my three favorites, from most cautious to most aggressive.


For momentum with a human touch, go with Brandywine fund. Its army of analysts checks companies' sales channels to see how products are moving before revenue numbers show up in earnings reports. This is labor-intensive, which is why other funds don't do it as strenuously. Other, purely quantitative momentum funds are always in danger of being made obsolete by more-sophisticated algorithms, but Brandywine's human intelligence is hard to replicate. I also like the fund's attention to valuation, which lessens risk. Brandywine (symbol BRWIX) held up reasonably well in the 2000-02 bear market as management shifted out of tech and into energy and other sectors.

Another impressive fund that doesn't get enough attention is American Century Vista (TWCVX). Lead manager Glenn Fogle has produced strong results since the bear market. Although, like hundreds of other momentum managers, he looks for earnings acceleration and price momentum, his track record is among the best. Like Bill D'Alonzo at Brandywine, he has boosted performance by letting momentum drive sector weightings so that he has been in the right industries at the right time.

Vanguard Growth Equity doesn't make those sorts of industry bets. Manager Bob Turner keeps sector weightings in line with those of the Russell 1000 Growth index. The idea is to keep the overall portfolio in line with the index, but beat the benchmark by picking stocks with strong momentum within each sector.

The result is oddly dependable. The Vanguard fund's absolute returns swing around like crazy, but you can count on the fund (VGEQX) to beat most growth funds and its index when growth stocks are running, and to lag when growth stocks are weak. Add the fact that the fund had to own a ton of tech to match its index in 2000 and you get some nasty losses in the bear market. So this is probably not a fund to own forever. But its low costs and disciplined strategy are a good way to give your portfolio oomph when growth stocks run.

Columnist Russel Kinnel is director of mutual fund research for Morningstar and editor of its monthly FundInvestor newsletter.