Investors of momentum funds have gathered mediocre results over the past decade. But some fund companies are still drawn to the strategy. By Russel Kinnel, Contributing Editor November 8, 2010 Recently my Morningstar colleagues and I met to discuss the question, "Is momentum investing dead?" After all, the practice has been essentially moribund since 1999. A momentum fund is one whose manager invests in companies with fast-rising earnings, strong share-price performance or both in hopes that all the good news about the stocks is not yet reflected in their prices. The idea is to buy high and sell higher. Most momentum funds delivered mediocre results over the past decade. Consider these ten-year numbers for some prominent funds (results are through October 8): American Century Ultra (symbol TWCUX) lost 2.4% annualized, Turner Midcap Growth (TMGFX) also lost 2.4% a year, and Brandywine (BRWIX) lost 1.0% a year. An Excuse Momentum managers do have a plausible defense for their performance. The kinds of stocks they tend to invest in hit absurdly high prices at the end of 1999, mainly because of the Internet craze. That all but guaranteed that the stocks would have trouble for some time in the new century. But the contrarian in me sees the dismal record of momentum investing as reason to dive in. The technique does find support in academic research. The most-successful strategy: Stocks that do better than the market over the previous 12 months, excluding the most-recent month, are likely to continue to outperform. When momentum works, it does so because investors don't immediately grasp all the reasons a stock is gathering steam. For example, when Apple introduced the iPhone, the early line was, "nice product extension of the iPod," not "monster new category." So even after Apple first started reporting big quarterly profits from the iPhone, you still had time to make money from the stock because future earnings reports would turn out even better. Other momentum angles are to buy shares of companies that repeatedly beat analysts' quarterly estimates and to conduct basic analysis designed to ferret out companies that are likely to top estimates when they issue their next report. Advertisement What's striking is that few momentum funds did as well as more-traditional growth funds, such as Jensen Portfolio and Amana Growth, which essentially look for solid companies that can generate good, long-term earnings gains. These funds were also handicapped by having to fish in waters filled with high-priced stocks at the start of 2000. That makes me wonder whether momentum investing simply isn't a sustainable strategy anymore. Maybe information spreads so rapidly now that any new product or other breakthrough is priced into a stock almost instantaneously. Yet some fund companies keep trying to cash in on Big Mo. AQR is the most notable example. Its founder, Cliff Asness, published some of the earliest research in support of momentum. In July 2009, Asness launched AQR Momentum (AMOMX), AQR Small Cap Momentum (ASMOX) and AQR International Momentum (AIMOX). Each picks stocks by ranking their performance over the previous 12 months, excluding the past month. Over the past year, the funds returned 17.4%, 15.2% and 9.3%, respectively, with each beating its benchmark. AQR Momentum charges 0.49% a year; the other two 0.65% a year. An alternative would be to buy one of the myriad of growth-style index funds or exchange-traded funds and pay expenses of 0.20% to 0.30%. A decent chunk of each fund would be in momentum stocks. My suggestion: Plug 10% of your stock-fund holdings into AQR's momentum funds or a growth-style index fund or two. You'll have exposure when momentum investing finally gets around to its next extended rally. For the rest of your portfolio, stay with active managers who have good fundamental approaches and a long-term focus. Columnist Russel Kinnel is director of mutual fund research for Morningstar and editor of its monthly Fundinvestor newsletter.