Investing in Sectors Takes Guts, Knowledge
Like a lot of investors, Chris Edwards is wondering whether he is ready for the world--and whether the world is ready for his money.
Edwards, a 30-year-old window washer from Chicago, saw Latin America funds tank during the peso crisis two years ago; he has watched Japan funds get battered for several years.
“I’m thinking . . . whether this is the right time to get in,” he says.
It’s a question a lot of investors are asking, thanks in large part to the rebound among Latin America funds, big winners during the first quarter of 1997, just two years after topping the list of laggards.
The average Latin America fund was up 13.68% for the quarter and is up almost one-third for the last 12 months. Emerging markets funds were hot too, rising an average of 9.57% in the first quarter of 1997. By contrast, the average general equity fund lost 1.98%, according to Lipper Analytical Services.
Spectacular performance breeds temptation. The possibilities, however, aree offset by the very real knowledge that anyone who dives into a specialized mutual fund could be just another lemming following the crowd into the abyss.
Keep in mind that specialized funds are not an absolute necessity in a portfolio. The average general equity fund has outperformed the average sector fund over the last three years (and over the last 15 years too, although there are time periods when sector offerings have had the lead).
But specialized choices do offer opportunity. A broad market decline may hit many sectors and depress a general equity fund; being invested in the sectors and regions that escape the downturn can mean making money when everyone else is losing.
The price for making the wrong choice, however, can be dear.
Consider Edwards’ preferred choices, Latin America and Japan. Edwards liked the looks of Latin America after the peso crisis, “but didn’t feel like I knew enough.” He felt more comfortable at the time with Japan--though he didn’t invest in either.
He missed the recent rise in the Latin funds. With Japan funds, however, he avoided an average three-year loss of 22.7%--6.7% during the first quarter.
“I still expect a turnaround,” Edwards says. “I’m just trying to figure out when it will be the right time to invest.”
Says Don Phillips, president of fund rater Morningstar Inc.: “Before investing in a country or a sector fund, you need to really determine that things have bottomed out. If you can’t figure that out, then you could be about to catch a falling knife. It takes guts to put yourself in that situation.”
Many people say they have the nerve but don’t.
For example, consider that when Latin funds begain repaying investors for their patience, many of those investors bailed out. Latin funds had some of the biggest percentage outflows in the business last year, suggesting that many investors hung around until they broke even, then headed for higher ground.
Even people with the stomach for it should limit country, regional and sector holdings to no more than 20% of a portfolio, regardless of whether they buy and hold or play “sector rotation”--moving money around in an effort to pick the hot arenas.
“This is one way of investing the most aggressive money in your portfolio, so it should be only that small portion that you are willing to allocate toward being super aggressive,” says Sam Stovall, author of the Standard & Poor’s Guide to Sector Investing. “You want something that fits with your portfolio and in a sector or country that you really understand, not something that simply had good returns recently.”
That understanding is crucial to staying the course. The broader market offers an example, albeit one involving less volatility. In 1989, the Standard & Poor’s 500 was up 30%.
Investors dove in, just in time for a 6% decline in 1990. Investors bailed out, only to miss another 30% move in 1991. That kind of volatility is more commonly associated with sector/country offerings.
“You see a good run and buy in, but much of the positive anticipation is gone. Generally, when J.Q. Public decides one area is attractive, the party is winding down,” says G. Edward Noonan, president of Triad Mutual Fund Investors Corp. in Hingham, Mass. “You can make a lot of money in these funds, but you need to be prepared for what happens if you are wrong.”
Which brings us back to Edwards, faced with his intuition about investing in Japan.
“I’m not generally one to time the market,” he says. “I just want funds that invest as aggressively as I intend to for the next 20 or 30 years.”
If a sector or country fund breaks your discipline--in Edwards’ case, that means making regular additional investments--it lies outside your comfort zone. That places a premium on having a compelling reason to buy.
Only by knowing the specialty thoroughly can you be comfortable that you are ready for the world, and not just greedily chasing performance.
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Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.
