Tired of chasing winning investments? Go for a loser
Investors are notorious for chasing the hot stock or the hot mutual fund, only to be gravely disappointed when they learn that past is not prologue, after all.
But as we rejig our portfolios for 2014, looking at who has been naughty and who has been nice to our annual return, why not consider investing in one of 2013's real stinkers?
It's a contrarian strategy, to be sure.
And it can pay off.
Take the Nuveen Tradewinds Value Opportunities Fund. The $562 million fund was the second-worst performing U.S. mutual fund in 2012, according to Lipper data that compared how the fund stacked up against its peers.
The fund posted a 2.05 percent return, underperforming its peer funds by 13.28 percentage points, according to Lipper.
But if you'd thrown your cash behind the fund in 2013, you would be up 24 percent while beating its benchmark and peer funds by 3 points and 1.4 points, respectively.
Of course, everyone likes a comeback story, but what if it comes with a broad stock market slide?
(Read more: Gold hits three-year low after Fed taper)
And nothing says stock market correction like Federated's Prudent Bear Fund, which is down 25 percent this year and lagging the S&P 500 Index by more than 50 points.
The $549 million fund, which had nearly $1 billion in net assets a year ago, is betting heavily that the S&P 500 will fall. It had a similar bet on in 2012, too, when the fund's total return was minus 17 percent, compared to a 0.78 percent gain among peer funds, according to Lipper.
On that score, the Prudent Bear Fund was the worst performing U.S. mutual fund in 2012, according to a Lipper analysis of funds with at least $500 million in assets.
However, if you're worried about the Federal Reserve reducing its bond buying and a frothy stock market that has seen the Dow 30 top 16,000, then maybe the Prudent Bear Fund is a place to park some cash.
In 2008, the fund threaded the needle during the height of the financial crisis, rising 27 points, or 64 points better than the swooning S&P 500 index.
The fund's management, team led by Douglas Noland, said in recent commentary that it has become obvious that the Fed's bond buying has fueled bubbles in the U.S. stock and corporate debt markets. They see the most speculative market environment going back to at least 1999.
Poor-performing funds can make their own corrections quickly, fueling returns that beat peers and their benchmark.
The recovery at the Nuveen Tradewinds fund happened as it cut its holdings to 50 names instead of 70. That increased its average position size by about 40 percent. Among its largest holdings are General Motors Co and Microsoft Corp, up 39 percent and 37 percent, respectively, in 2013.
"We increased our conviction level," said Joann Barry, an analyst and portfolio manager for the fund.
Another important thing to know about the fund is that its active share is about 92 percent. That represents the proportion of the fund's holdings that are different from the composition found in its benchmark.
"We're active managers. They don't pay us to hug the benchmark," Barry said.