Course Correction

With fears of an economic about-face, how can you keep your fund portfolio on the right track?

an analyst at Morningstar Inc., recommends investing in mutual funds that are diversified among different asset classes emphasizing past performance and experienced management.

Coumarianos recommends looking into foreign stocks. Morningstar’s category of Pacific/Asia stock funds that excludes Japan was up 13.68% in the first half, followed by Latin American (13.20%) and European (13.14%) stock funds, as investors continued to find better values and opportunities outside the U.S. Foreign stock funds have outperformed domestic entries every year since 2001.

Other categories investors should consider include:

Precious metals. These types of funds were the big winners, gaining 22.50% in the first half of this year. They invest heavily in mining stocks, especially gold mines. “Gold is viewed as an inflation hedge,” says Coumarianos. Inflation worries have contributed to higher gold prices in recent years; higher gold prices, in turn, have boosted the share prices of mining companies and the mutual funds owning their stocks.

Real Estate/Energy. Strong returns also were posted by real estate funds (up 12.44%) and natural resources funds (11.95%), which have large holdings of energy stocks. Real estate, oil, and natural gas are all expected to gain value in inflationary times, so these funds were popular. If you’re worried about a correction in 2007 driven by higher inflation, you might want to hold such funds in your portfolio.

Small companies. Among domestic funds, the small-value and small-blend (which hold a mix of small-company growth and value stocks) categories led the way, both gaining about 7% in the first half.

While the superior performance of precious metals, real estate, and natural resources funds can be attributed to inflation concerns, what explains the strong results from foreign stocks and, to a lesser extent, small U.S. companies? After all, even the domestic giants struggled much of the year. Funds holding large-company growth stocks, the darlings of the 1990s bull market, lost more than 1% in 2006, through June.

“We’re still seeing some rebound from the late 1990s,” says Coumarianos. “Back then, investors invested heavily in large growth stocks, especially tech stocks. Foreign stocks and small-cap stocks were all but forgotten, so they became undervalued.” The bear market of 2000 to 2002 demolished tech stocks, so investors turned to small caps and foreign stocks, trends that continue to run.

“Some foreign companies, especially in Asia and Latin America, participate in metals, mining, or oil,” says Coumarianos. “Those industries are attracting investors now after many years of neglect.” In addition, investors learned the risks of overloading on one type of mutual fund, so diversification into lesser-known areas has gained popularity.

Proverbial Profits
Another fan of American Funds is Kevin Davis, a certified financial planner with Consolidated Financial Services in Dallas. “I used to be a recruiter,” he says, “and I heard that it was hard to place money managers with that company. Only the top people got jobs there.”

Such selectivity has resulted in investment success. “The funds might be the turtle rather than the hare,” says Davis. “They may not have the best returns in any one year, but they’ll finish first over

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