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Scene-Stealing Funds

These supporting players could add punch to your portfolio.

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Back in January, we created a screen for riskier funds with attractive long-term risk/reward profiles. That time we used the Morningstar Risk measure as our guide, which ranks a fund's volatility compared with peers' and penalizes downside deviations more than upside bumps. This time we're going to use a more absolute measure of volatility, standard deviation--which tells you how far off its average return a fund has tended to stray--to find some highly volatile funds that have still managed to achieve category-topping long-term returns. Investors who are willing to endure more volatility generally expect higher long-term returns to compensate for additional risk, although that's not always what they get. These funds won't always be scene-stealers in a way that makes you grin or slap your knee. In some years they could flat out scare you. It's also worth noting that a fund's past risk/reward profile isn't necessarily a good indicator of how it is apt to behave in the future. Funds with big fundamental risks often have low standard deviations, and funds that have generated high past returns may in fact be poised to fall. Most of the funds on our list, therefore, are best used in very small doses, if at all.

To construct this screen in using the  Premium Fund Screener, we selected "Distinct Portfolio Only," which limits the results to one share class per fund. Next, we wanted to see only the funds with time-tested managers, so we selected manager tenures of 10 years or more. We also selected funds with below-average expense ratios that are open to investments of $20,000 or less.

Now, on to the risk measure. When selecting the level of three-year standard deviation the Premium Screener helps you target specific ranges by dividing funds into quartiles based on their standard deviations. We selected a level of 11.27 or greater for this measure, as this will include funds that fall in the upper half of the volatility spectrum. In addition, we winnowed down that list to the highest-returning quartile: those with 10-year annualized returns of 9.6%.

To see the full list of funds,  click here. The screen produced a wide range of funds, but most of them fell into one of the following three buckets:

Sector Funds
There are a handful of specialty funds on the list, including  Blackrock Global Resources (SSGRX) and  GAMCO Gold AAA (GOLDX). These funds' respective focuses on natural resources firms and gold producers mean that when those particular market sectors sink, returns have no where to go but down. The specialty-precious metals funds on this list have the highest standard deviation and have experienced some of the most dramatic losses. For example,  American Century Global Gold (BGEIX) lost 22.8% of its value during the month of April 2004. So, unless you have a very steady hand when in comes to your investments, make sure your investment in this type of fund is truly a supporting role.

 CGM Focus (CGMFX), while not a sector fund, has been similarly beholden to the fortunes of energy and other commodities over the past year. Ken Heebner is a talented manager, but the fund's sky-high volatility and recent bruising losses are a strong indication that you need nerves of steel to own it and you should relegate it to a small slice of your portfolio.

Small- and Micro-Caps
Also on the list of high-volatility/high-reward funds are some that invest in thinly traded small- and micro-cap stocks. Take  Perritt Micro Cap Opportunities (PRCGX), for example. The fund has an average market capitalization of $250 million, which is quite different from the typical small-blend fund's $1.7 billion average. Because these issues are thinly traded, it can be hard to build or sell positions without significantly affecting the stock's price. So, investors need to be prepared for the fund to be out of step with the small-blend category at times.

Emerging Markets
Lastly, funds that focus on emerging-markets stocks, such as  T. Rowe Price Emerging Markets (PRMSX), made it through the screen. If you look back at T. Rowe Price Emerging Markets' calendar year returns over the past 10 years, you'll notice that double-digit losses are about as frequent as double-digit gains. Even so, the team at T. Rowe Price has done a good job navigating the bumpy emerging markets and locked in a compelling risk/reward profile over the past five- and 10-year stretches.

Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.