When it comes to picking mutual funds, Janet Brown turns conventional wisdom on its head. Brown couldn't care less about the name of a fund's manager, its holdings, its fees or its long-term record. Instead, she selects funds in her NoLoad Fund*X newsletter and for her small but expanding family of mutual funds exclusively on the basis of their short-term performance.
Brown isn't alone in using a momentum strategy for picking funds. But her record is one of the best. Over the past ten years to April 1, NoLoad Fund*X was the top-performing fund letter, according to the Hulbert Financial Digest, which tracks investment letters.
Fund*X has beaten the U.S. stock market every year since 1997, when Brown acquired the firm that publishes the letter. Her flagship fund, FundX Upgrader, which she launched in late 2001, has lagged the market slightly so far in 2008. But it is coming off five straight years of double-digit gains.
With success has come wealth that Brown, 57, could hardly have imagined when she went to work for Fund*X's founder, Burt Berry, in 1978. Today, Dal Investment -- named after Berry's children, Douglas and Linda -- has 21 employees, reaches 14,000 subscribers with its bimonthly newsletter, and manages $2.3 billion in mutual funds and separate accounts. Brown, who works out of a corner office overlooking San Francisco's financial district, won't disclose financial details, but we estimate Dal's 2007 revenues at upwards of $25 million.
A simple formula
All of this hinges on an investment strategy as simple as a game of tick-tack-toe. To home in on hot funds, Fund*X averages the one-, three-, six- and 12-month returns for each of the 1,300 mutual funds and exchange-traded funds it tracks. A fund earns a bonus each time it lands among the top 15 funds in one of the four time periods.
Fund*X then ranks the funds by the resulting scores. It calls the top 13 to 15 funds "buys." All the others in the top 30% are labeled "holds," and lower-ranked funds are called "upgrades," which readers are instructed to sell and replace with funds from among the "buys." "It's really a very unsophisticated process," says Berry, who still keeps an office in Dal headquarters. "It's just the idea of progressively moving your money into the funds that are doing well."
Berry, 86, himself took a roundabout route to investing. After earning a business degree from Stanford in 1943, he spent the rest of World War II in Texas as a B-17 pilot, waiting for orders to go overseas that never came. After the war, he dabbled in real estate while learning about mutual funds, before deciding to pursue his funds hobby full-time.
Berry founded Dal in 1969 to manage retirement accounts for a small group of private clients. For years, he followed a back-of-the-envelope momentum strategy -- focusing on no-load funds that were hitting the top of the charts of the few newsletters that tracked them. He started Fund*X in 1976 to publish performance results on the 120 or so no-load funds then in existence, typing figures on 8-by-11-inch sheets of paper.
Brown, who radiates the effortless cheer of a native Californian, came to funds by chance. After graduating from San Diego State with a degree in art and architecture, she worked in Brussels for a U.S. financial-services company. When she returned to the States, she answered an ad for a position as Berry's assistant. "I needed a job," Brown recalls. "That's how I got interested in investments."
She started by crunching numbers, then assumed more responsibilities as Dal grew. She eventually took on money-management responsibilities and became managing editor of the newsletter. When Brown purchased Dal from Berry in 1997, the company employed nine people and managed about $200 million in private accounts.
Today, the 16-page letter offers fund rankings, market commentary and directions for readers who want to follow its strategy. A key element of Fund*X's approach is its system of categorizing funds according to risk.
Brown divides the universe into five tiers based on what funds invest in and their volatility -- the degree to which their returns have swung in the past. Funds are then ranked within their risk class. Pure stock funds and certain specialty funds are assigned to three classes. Class 1 consists of the most speculative funds; class 3 includes high-quality, diversified funds; and class 2 contains funds with risk levels between those of classes 1 and 3.
A fund that invests solely in India might end up in class 1, but a diversified emerging-markets fund might land in class 2. Class 4 contains funds that invest in a mix of stocks and bonds. A fifth class contains bond funds, which Fund*X doesn't rank.
The riskier classes have been wildly inconsistent. Class 1 picks have, on average, returned 13% annualized since mid 1980 (when Mark Hulbert's Hulbert Financial Digest began tracking newsletters), beating Standard & Poor's 500-stock index by an average of one percentage point per year. But the class 1 choices have trailed the market in 15 of 27 calendar years. Class 2 picks have topped the market most of the time, but they, too, have been prone to big swings.
Star of the show
Fund*X's class 3 recommendations have consistently shined. Since mid 1980, those picks have returned an annualized 17%, an average of nearly five percentage points per year better than the S&P 500, with a hair less volatility. In fact, class 3 funds have performed so much better than those in other categories that since late 1989, Fund*X has deemed the funds at the top of that category to be its model portfolio -- essentially, its true recommendations.
Why does a momentum-based approach to fund picking work so well? Mark Hulbert surmises that it's because stocks that perform well for six to 12 months tend to continue to excel, at least for a few more months. "Funds that have owned more of the stocks that have done well will continue to outperform for another few months."
As for why Fund*X's class 3 picks outpace the more aggressive picks, it's probably because the more sedate funds surrender less during market hiccups. The largest 12-month loss in the past 28 years for class 3 selections was 22%; the biggest for class 1 funds was 43%. Brown says she continues to offer the racier portfolios because she believes the funds they contain can boost returns for investors who can tolerate greater risk.
One of the strategy's most impressive achievements is how it navigated the 2000-02 bear market. According to Hulbert, subscribers who followed the letter's class 3 recommendations made money in 2000 and 2001, years in which the S&P 500 lost 9% and 12%, respectively. The class 3 picks lost 14% in 2002 (their worst yearly performance ever), but that still bested the S&P by eight percentage points.
Three other momentum-based fund newsletters struggled during the downturn. The All Star Fund Trader's portfolios gained 21%, on average, in 2000, but then surrendered that (and then some) by losing double-digit amounts in 2001 and 2002. Equity Fund Outlook also lost money in two of those three years, while Moneyletter's average portfolio lost money in all three years.
Brown, who owns a house on Richardson Bay in posh Marin County, likes to compare investing with sailing, her favorite hobby. "You just need to adjust your sail to ride the prevailing winds," she says. And that, in essence, explains how Fund*X avoids disaster.
Early in the decade, the letter's system gradually produced a shift in its list of recommended funds from those that emphasized large, growing companies -- stars of the late 1990s -- to those that favored small, undervalued companies. Most small-company value funds, which had performed miserably in the late '90s, made money during the 2000-02 downturn.
Saving customers' skins
The Fund*X strategy does not move clients into cash during a bear market. However, funds with big cash positions or those that may have hedged their exposure to stocks by selling short or buying put options are likely to see their rankings improve. "In a down market, the top-rated funds may just be losing the least," says Brown.
She stresses that the strategy won't get subscribers out near a market peak or in at a bottom, but that it usually enables investors to capture broad shifts in market leadership. "We're not trying to get the short-term events," Brown says. "We're trying to capture the major trends that last four or five years."
And because major trends, such as the dominance of large-company, small-company or foreign stocks, tend to stay in force for several years, capturing those moves goes a long way toward stacking the odds in a particular strategy's favor.
One thing that isn't a short-term event is learning how to follow Fund*X's recommendations. Even the letter's production editor, Jeffrey Smith, says its tables are so unwieldy that it can take readers months to learn how to follow its recommendations. The proliferation of short-term redemption fees also adds to the difficulty of using the system.
Riding to the rescue of the bleary-eyed are four FundX mutual funds that basically blend the newsletter's four portfolios. Buying a FundX fund spares investors the hassle of frequent trades, which can trigger redemption fees and always result in a blizzard of 1099 forms come tax season.
The downside is that the funds are expensive. Consider FundX Upgrader (symbol FUNDX), the family's oldest (launched in late 2001) and biggest (with assets of $800 million at last report). The fund's nominal expense ratio, which represents management fees and other routine fund costs, is 1.11%.
But once you add the expenses of the underlying funds, Upgrader's expense ratio zooms to 1.90%. That compares with 1.34% for the average diversified domestic stock fund.
Brown's response is that it's bottom-line performance, not cost, that matters. On that score, Upgrader is doing just fine.
From its inception to April 1, the fund, which invests mostly in class 3 funds, returned an annualized 11%. That outpaced the S&P 500 by six percentage points per year, on average, and beat the typical global-stock fund by an average of two percentage points per year. (In the first three months of 2008, Upgrader lost 9%.)
Indeed, because the FundX funds can -- and do -- roam far and wide, it makes more sense to compare them with global benchmarks than with U.S.-oriented funds or the S&P 500. At last report, according to Morningstar, Upgrader had 83% of its assets in foreign-stock funds.
Starting in 2005, Brown began adding more-exotic funds. Two that invest exclusively in exchange-traded funds fall within Dal's traditional area of expertise. But two others venture into new territory.
One, FundX Stock Upgrader (STOCX), applies the Fund*X formula to the S&P 500 universe of stocks. So far, it has trailed the index slightly.
In February, Brown launched FundX Tactical Upgrader (TACTX), which practices market timing -- at times moving money from stocks to cash as dictated by a complex formula. We don't find either of these two newcomers compelling.
But as for Dal's bread and butter -- its newsletter's class 3 picks and FundX Upgrader -- it's hard to ignore the fine results. If, however, you're the kind of investor who cares about costs and wants to know who's running your money, you'll need to make a leap of faith to entrust your cash to a strategy that cares about neither.
Amazon To Offer Students $25 Flights For The Holidays — But You Must Act Fast
Amazon Prime Student members will have a chance to score one of 3,000 tickets for a limited time, starting December 5.
By Jamie Feldman Published
Walt Disney's Dividend Is Back. Will DIS Stock Follow?
Disney reinstated its dividend after a three-year suspension as shares remain depressed.
By Dan Burrows Published
Best Banks for High-Net-Worth Clients
wealth management Kiplinger's 2023 list of the best banks for higher-net-worth clients.
By Lisa Gerstner Published
Stock Market Holidays in 2023: NYSE, NASDAQ and Wall Street Holidays
Markets When are the stock market holidays? Take a look at which days the NYSE, Nasdaq and bond markets are off in 2023.
By Kyle Woodley Last updated
Stock Market Trading Hours: What Time Is the Stock Market Open Today?
Markets When does the market open? It's true the stock market does have regular hours, but trading doesn't necessarily stop when the major exchanges close.
By Michael DeSenne Last updated
Bogleheads Stay the Course
Bears and market volatility don’t scare these die-hard Vanguard investors.
By Kim Clark Published
I-Bond Rate Is 5.27% for Next Six Months
Investing for Income I-Bonds issued November 1 to April 30 will have a rate of 5.27%.
By David Muhlbaum Last updated
What Are I-Bonds?
savings bonds Inflation has made Series I savings bonds enormously popular with risk-averse investors. So how do they work?
By Lisa Gerstner Last updated
This New Sustainable ETF’s Pitch? Give Back Profits.
investing Newday’s ETF partners with UNICEF and other groups.
By Ellen Kennedy Published
As the Market Falls, New Retirees Need a Plan
retirement If you’re in the early stages of your retirement, you’re likely in a rough spot watching your portfolio shrink. We have some strategies to make the best of things.
By David Rodeck Published