Funds Stage a Comeback: Time to Forgive and Forget?

A fund I still think going to be good is T. Rowe Price Cap Appreciation. It's a balanced fund that was down 27 percent last year and is now up 12 percent. The reason it was down is that they have corporate bonds in there, and corporate bonds got crushed even if they were good companies—nobody wanted anything but treasuries, and high-quality stocks got crushed. If you look at its long-term track record, it's in the top 2 percent of all balance funds.

What are some trends you're seeing in 2009?
One interesting thing is that I've seen lot of managers who would normally have 100 stocks in their portfolio but have taken it down to 50 or 60. Stocks were beaten up for no reason, and if they were concentrated, they really got beaten up. We are in a stock picker's market. So actively managed funds are a good place to be. Take an index fund that follows the S&P 500—they had to hold GM until the day it went bankrupt.

A lot of the good managers are concentrating their portfolio in a few stocks they feel good about. We have had this volatility and bounce, and a number of managers have picked up the level of turnover in their portfolios. There's been a lot of sector rotation going on, so even managers that haven't traded much are trading more. They'll sell stocks after they've had a 35 percent to 40 percent run and go into something hasn't run as much. As we return to more normal markets, the amount of trading will normalize.

[Slide show: The Top 25 Market Movers of 2009]

As the market improves, where are individual investors putting their money? The numbers show that many are piling into riskier asset classes.
I'm weary of the emerging markets. It scares me to death—people are doing the wrong thing; they buy at the wrong time. The market recycles, and you want to be where it goes next, not where it's been. China's up 85 percent from its lows, and when I see 60 percent to 65 percent fund flows going to emerging markets, it feels like when people chased tech stocks in '99 or oil stocks at end of 2007. There's no question that China and India will become large financial powers, but the question is how much of that [expectation] is already built in.