Fashions fade. Consistency is a constant

Japan, emerging markets and resources were the place for investors last year: seven of the 20 top-performing funds, as measured by Lipper, were Japanese specialists; five were general emerging market funds; and a further six specialised in various emerging regions, such as Korea, Latin America or Russia, and two were energy funds.

Bonds, however, were best avoided: the sector accounted for 14 of the bottom 20 funds, including the only four which actually lost money. But before you cash in your bond funds and rush into Asian emerging markets, you should heed the warning that past performance is not necessarily a guide to the future. All too often, one year's stars are the next year's dogs. An analysis of previous winners, prepared for The Observer by adviser Best Invest, found that in each of the past seven years some of the best funds in one year have ended up in the bottom ranks the next.

There are various reasons why funds can fall so dramatically from grace. The most important is that investment, like fashion, is driven by fads. Countries, regions, asset classes, sectors and companies can all fall in and out of favour depending on anything from economic trends to investors' appetite for risk. The more specialised the fund, the more pronounced the swings in sentiment are likely to be. Indeed, annual performance tables are usually dominated by specialist funds: managers who are lucky enough to be in the latest go-go area are likely to perform well, almost regardless of their skill and expertise.

Last year, the key investment fads were commodities, stimulated by the healthy growth in China and India, which stimulated the economies of Russia and Brazil in particular but also other resource-rich emerging markets, particular in Latin America. Japan, too, became fashionable again, particularly in the second half of the year, as it looked likely to finally emerge from decades of deflation and move towards more normal interest rates. Thus, even the worst-performing Japanese fund - Aberdeen's Japan Growth - made more than 25 per cent in 2006.

These themes may well continue for another a few months, or even years, though some commentators are already warning that commodity prices are overstretched and could start to fall, as the oil price is already doing.

But it is a safe bet that they will run out of steam. Japan is a perfect example of that: specialist Japanese funds were all the rage six years ago, the last time investors were betting that it could drag itself out of deflation and start to function like a normal economy again. The bet was wrong: two of the best-performing Japanese funds in that year, Invesco Perpetual's Japan Smaller Companies and JP Morgan Japan, plunged to the fourth quartile the following year.

Other years have been equally driven by fads. Perhaps the worst example was technology funds, which dominated the performance tables in 1998 and 1999 as internet fever gripped investors: many of those who were sucked in will know that many such funds have still not recovered from the losses suffered in subsequent years. But there have also been fads for bond funds, healthcare, China or 'focus' funds, which heavily back just a small number of companies or ideas. All have run out of steam - and often pretty quickly.

But funds can also top the performance tables because their manager got big bets right, as Michael Barnard did with his Marlborough UK Equity Growth and Income funds in 2004. Last year, however, his heavy bets on financials such as Royal Bank of Scotland were less successful and his two funds did poorly, though their long-term performance remains excellent.

Just as star performances can dim, dogs can regain their pedigree, but it seems much harder to do. While funds that are doing badly for economic or cyclical reasons - like the bond funds last year - will recover as economic circumstances and investor attitudes change, those that are simply badly run or poorly invested will generally stay that way.

BestInvest's annual Dogs report, which lists funds that have been in the bottom quartile for three years, finds that many never leave. The exceptions, says the firm's Justin Modray, are those - such as Artemis Global Growth - which take radical action like changing the manager. That does not happen often enough.

Investors can often be sucked into investing in short-term fads by fund managers, who rush out new launches to take advantage of a burst of good performance. That certainly happened with technology shares but has also been seen in areas such as small companies, emerging markets, Japan and bonds.

Indeed, a useful rule of thumb is that the worst time to buy a particular type of fund is whenever fund managers are falling over themselves to launch new ones. There has not been much launch activity in recent years, but the indications are that retail investors are starting to regain an appetite for shares which could spark a wave of new issues. If so, beware those cashing in on old fads, like Japan, Brazil, Russia, India and China or resources.

The best approach is to ignore annual performance and look for consistency. Few managers can shine every single year, but the best consistently do better than their peers. Tim Cockerill at adviser Rowan grades managers according to factors such as consistency and volatility over three years, which highlights how few manage reliable outperformance. Of the 69 equity income funds he considers, only one, Framlington Monthly Income, scores an A grade and a further four - Invesco Perpetual's High Income and Income funds, Framlington Equity Income and New Star's UK Strategic Income - manage a B, while 42 languish at F.