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Spread Investment Eggs Among Several Baskets

RUSS WILES <i> is editor of Personal Investor, a national consumer-finance magazine based in Irvine. </i>

Spread your eggs among several baskets. What better time than Easter weekend to bring up this tried-and-true investment axiom? Perhaps the biggest advantage of mutual funds is that they deliver widespread diversification to individuals with modest sums of money. With a well-rounded equity portfolio, you will surely participate in any stock market upswing.

Yet some funds purposely avoid broad diversification. Roughly 150 “sector” funds focus on companies in a particular industry, hoping to strike a rich investment vein by narrowing the field. You might think of a sector portfolio as a compromise between purchasing an individual stock and buying a well-diversified fund, in that you can concentrate your financial firepower while reaping the other benefits of mutual funds.

With certain notable exceptions, sector portfolios have gained a reputation for being more risky than mutual funds in general, owing to their non-diversified nature. This image has been bolstered by the fact that many market timers and short-term traders have found in sector funds an excellent vehicle for jumping from one hot market segment to the next.

For example, TeloFund, an investment advisory service in Atlanta, directs its subscribers to switch anywhere from eight to 12 times a year, concentrating all their cash in one Fidelity or Vanguard portfolio at a time. Fidelity, Vanguard and other families with numerous sector funds generally make it quick and easy for smaller investors to move from one portfolio to the next, typically with a phone call.

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Some of the more volatile sectors include science/technology, financial services, real estate and, especially, gold. Morningstar Inc., a Chicago-based fund tracking service, figures that the typical gold portfolio carries about twice as much downside risk as the average growth stock fund.

However, not all sector funds are treacherous nor do they necessarily make poor long-term investments. Utility funds represent the classic example. These portfolios hold stakes in electric, natural gas and telephone companies. Owing to the non-cyclical nature of these businesses, many utilities face fewer business risks than companies operating in other industries, and many can point to steady profits. Also, utilities pay generous dividends (recently about 6.6% on average), a factor that supports their stock prices.

Because of these high yields and the leveraged nature of the utility business, the stocks often trade like bonds, rising and falling according to interest rate changes. For conservative investors, the funds can be a good way to take that first, tentative step into the stock market. Morningstar estimates that the typical utility fund carries only about two-thirds the downside risk of the average growth stock portfolio.

One word of caution, however: The telephone business is shedding its image as a staid industry. Thanks to deregulation, the advent of cellular phones, the explosion in fax transmissions and other factors, many telephone utilities can be classified as growth companies. Utility funds that take a big telecommunications weighting may be riskier than their peers.

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Funds with superior long-term records include Fidelity Select Utilities (3% load; 800-544-8888), Flag Investors Telephone Income (4.5% load; 800-767-3524), Franklin Utilities (4% load; 800-342-5236) and Prudential Utility (5% deferred load; 800-225-1852). It’s worth noting that the typical utility portfolio beat the average equity fund over the one-, five- and 10-year periods ending Dec. 31, 1990, according to Lipper Analytical Services.

Another lower-risk sector fund outside the utility area is the Fidelity Select Food & Agriculture Portfolio. Jack Bowers, publisher of the Fidelity Monitor newsletter in Rocklin, Calif., figures this fund fluctuates in price 11% less than the stock market.

Fidelity Select Food & Agriculture concentrates its holdings in stocks such as Philip Morris, Pepsico, Coca-Cola and Nestle--big corporations with leading brands operating in a non-cyclical business. “Food companies are inherently stable. We all have to eat,” notes David Calabro, the portfolio manager.

Investors flock to food shares during periods of economic weakness, which partly explains why the fund has done well lately. “If the economy strengthens, cyclicals would be more attractive on a short-term basis than defensive stocks such as food and beverage issues,” Calabro admits. But longer term, he believes the companies his fund holds will fare well because of the steady profits they crank out. Bowers agrees and rates Fidelity Select Food & Agriculture as his only long-term sector holding for conservative investors.

Then there are industries that, despite short-term fluctuations, can be expected to flourish over the long haul. One such category is the health field, a generally non-cyclical business that already accounts for about 11.5% of the U.S. gross national product and will likely take a larger share in the future. Another example is pollution control, for which nationwide expenditures are expected to jump 86% between 1987 and 2000, according to a recent study by the Environmental Protection Agency.

Top funds in the health group include Fidelity Select Health Care (3% load; 800-544-8888), Financial Strategic Health Sciences (no load; 800-525-8085) and Vanguard Specialized Health Care (no load; 800-662-7447). Leading funds in the nascent pollution-control group include Fidelity Select Environmental Services (3% load; 800-544-8888), Freedom Environmental (4.5% load; 800-225-6258) and Oppenheimer Global Environmental (4.75% load; 800-525-7048).

And many other industries will no doubt blossom from time to time in the years ahead. Bowers suggests that you keep your eyes open for new opportunities in your own business or that of a spouse, relative or friend, and invest accordingly, perhaps in a sector fund. “A lot of people who work in a certain industry may have special knowledge of how it operates,” he says. “That can . . . put them ahead of the market.”

SECTOR STANDINGS Not all mutual funds seek wide diversification. Roughly 150 “sector” portfolios buy stocks in one industry only, allowing investors to concentrate their bets in specific corners of the market. Certain groups, such as the utility and food industries, have been stable performers over the past five years. Others, especially gold portfolios, have fluctuated wildly. This chart lists average total returns for funds in 10 industries; the numbers in parentheses show the relative rankings for each year.

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Sector 1986 1987 1988 1989 1990 Environmental -- -- +11% (7) +28% (6) -9% (6) Financial +14% (7) -13% (9) +19% (3) +26% (7) -15% (7) Food +23% (3) +8% (2) +27% (2) +39% (2) +9% (2) Gold +36% (1) +36% (1) -15% (10) +23% (8) -22% (10) Health/Biotech +17% (6) -3% (6) +11% (8) +44% (1) +19% (1) Leisure +17% (5) +3% (4) +27% (1) +35% (3) -17% (8) Nat. resources +8% (9) +5% (3) +12% (6) +32% (4) -8% (5) Real estate +18% (4) -11% (8) +18% (4) +6% (10) -17% (9) Science/Tech +8% (8) +2% (5) +9% (9) +22% (9) -3% (4) Utility +23% (2) -8% (7) +15% (5) +29% (5) -2% (3)

Source: Lipper Analytical Services


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