Considering Sector Funds
Regardless of war or recession, there will always be some industries whose fortunes are rising or are on the verge of such turns. Last year, health care was red-hot. Lately, technology stocks have soared.
But when investors try to make bets on individual industries, they find themselves confounded by the question of which stocks to buy--or by the mechanics of building such a focused portfolio.
There is a fairly simple way to make such narrow bets, however: so-called sector mutual funds, which invest solely in stocks of specific industries.
These funds may get more attention in coming months as the market wrestles with the question of which industries will lead the next major bull move--whenever it arrives. It’s entirely conceivable that stocks have yet to hit their lows in this bear market, especially if the Persian Gulf war rages on and/or if the economy continues to sink. But many investors now are less concerned with the lows than with which stock groups will rebound fastest when the bear ends.
In the realm of sector funds, nobody is bigger than Boston-based Fidelity Investments. It manages 35 sector funds under the “Select” fund title. The industries targeted by the Select funds include automotive, leisure, insurance, retailing, construction and software, to name a few. The minimum investment is $1,000.
Ever since Fidelity introduced these funds in the mid-1980s, there has been a debate over how best to use them--as short-term trading vehicles or as long-term investments. Initially, at least, many people traded them. But over time, Fidelity found it necessary to impose fees that make it much less lucrative to try to trade the funds constantly for a quick buck. And that has caused many of the funds to shrink dramatically.
“A lot of the hot money has left,” says Eric Kobren, publisher of Wellesley, Mass.-based Fidelity Insight, an independent magazine that covers Fidelity funds.
But even with the fees, an astute investor who knows how to trade may still find sector funds intriguing, says Michael Lipper, head of fund tracker Lipper Analytical Services in New York. Trading intelligently, he says, “usually means being slightly anticipatory of trends. If you possess that kind of skill and can invest the time to follow your (portfolio), then narrowly based funds make sense.”
Anticipating trends sometimes involves nothing more than taking a logical approach toward basic market psychology. Last year, for example, many biotech companies finally began to make real money, after years of red ink. Astute investors saw that turn last spring and realized that biotech would become a new “story” on Wall Street. Indeed, biotech stocks--and the sector funds that targeted them--were the hottest market investments of 1990. The Select Biotech fund jumped 44.4% last year.
But market trends also can last for many years, which is why it’s unfair to label sector funds purely as traders’ tools. The long-term investor who sees powerful economic changes benefiting specific industries also can use sector funds to his or her advantage.
In the chart above, take a look at the performance of the Select Food and Select Health funds over the past five years, ended Dec. 31, 1990. The food fund, up 153.4%, dramatically outperformed the average general stock fund, which gained 54.5%.
Surprisingly, even some basic industry Select funds, such as the chemical stock fund, rose more than the average stock fund in the five-year period. The Select Chemicals fund jumped 98.2%.
But the Select fund universe also had its dogs. There may have been plenty of opportunities to trade in and out of the Select Defense fund over the past five years, but a buy-and-hold investor in that fund for five years had lost 12.9% of his or her money by the end of 1990.
That’s why the sector funds will always be much riskier than a general stock fund that invests across many industries. Don Phillips, editor of Mutual Fund Values newsletter in Chicago, notes that the very nature of the sector funds is that they “diminish some of the benefits of the mutual fund concept’--specifically, the idea of diversification.
Phillips advises potential sector-fund buyers that they’ll have to do their homework and look carefully at what’s in a fund before they buy. For example, he notes that the Select Computer fund gained 18.4% last year, but for much of the year “it didn’t own any of the names you’d expect to see in a computer fund,” such as IBM and Digital Equipment. Instead, the fund manager made a big bet on producers of computer peripheral equipment.
Finally, Fidelity Insights Publisher Kobren warns that traders, especially, have to recognize the fees involved. There is a 3% sales charge to buy a Select fund. Whenever you trade out of a Select fund, you pay a flat fee of $7.50 if you’ve held your shares for 30 days or longer. If you’ve held them for 29 days or less, you’ll pay a fee of 0.75% of the amount redeemed.
SECTOR FUNDS Fidelity Investments offers mutual funds that target stocks in individual industries--a way for investors to make specific market bets. How some of the funds have performed:
Total return: Fidelity fund 5 yrs. 1990 Select Food +153.4% +9.3% Select Health +133.5% +24.3% Select Chemicals +98.2% -4.2% Select Utilities +83.3% +0.6% Select Retailing +80.2% -5.0% Select Leisure +57.6% -22.3% Select Computer +21.3% +18.4% Select Air Trans. +20.4% -18.2% Select Automotive +13.3% -6.7% Select Defense -12.9% -4.6% Avg. general stock fund +54.5% -6.3%
5-year data through Dec. 31
Source: Lipper Analytical Services
