Works for me. I created a new folder in IE Favourites/Feeds (had to create it as a subfolder of an existing folder and then drag it to the top level, but never mind). Added three feeds to "New Folder". Select "New Folder" in the gadget options and headlines from all 3 feeds appear (although, for some reason, it took a few minutes for them all to show up).
Update - changed the selection then changed it back again to the new folder. Now only one feed shows. Definitely a bit flakey.
Update2 - and now they're all back again. Seems it just takes a while for all the feeds to show.