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THE NO-LOAD FUND INVESTOR
410 Saw Mill River Rd., Ste. 2060, Ardsley, NY 10502.
Monthly, 1 year, $139.
Why consider sector funds?
Sheldon Jacobs: "Sector funds offer you the opportunity to own diversified portfolios in various segments of the stock market. If you think energy, technology, bank/financial-services or healthcare stocks are attractive candidates for growth, it is often advantageous to buy the entire sector as opposed to trying to pick individual stocks within the sector. When you buy a sector fund, you get a working portfolio of stocks that will benefit if that sector moves. The potential rewards are great: unlike well-diversified funds that embrace many different industries, sector funds allow you to focus on those areas of the stock market that are primed for maximum appreciation.
Used in conjunction with broad-based equity funds, sector funds can enhance diversification and adjust your industry exposures. For example, the currently hot technology and telecommunications sector has approximately a 22% weighting in the Wilshire 5000 index. Using the Wilshire 5000 as a benchmark while investing in a tech-stock fund would bring your tech exposure to a level above 22%.
Sector funds are commonly found in our "Top 20" performance listings. That's because they are non-diversified, which gives them a better chance of producing superior performance than broadly diversified funds. The corollary, though, is that sector funds also have a better chance of doing poorly. The range of performance among these specialized investments is enormous - much larger than among diversified growth funds. Fidelity's sector funds are typically among the best - and worst - performers along all equity funds. In some years, they encompass practically the entire spectrum of mutual-fund performance. In the twelve months ended September, sector funds accounted for eleven of the top 20, including the top performer, RS Info Age, up 131.8%. At the other extreme, the worst-performing fund for the period (excluding bear funds) was Fidelity Select Medical Delivery, off 12.6%.
Since various sectors have different risk levels, you can use sector funds to adjust your overall portfolio risk either up or down. At one extreme a selected sampling of no-load healthcare funds (excluding biotech) has an average beta of only 0.44. At the other extreme, technology and telecommunications funds have an average beta of 2.26, far above the market's level of 1.00. Biotech funds also have high betas: an average of 1.36. The other sectors have betas mostly in the 0.70 - 0.90 range.
Where Sector-Fund Investors Go Wrong
Notwithstanding the often-excellent performances of sector funds, surprisingly few of their shareholders actually pocket large gains. The problem is that investors usually fail to appreciate important differences between sector funds and diversified growth funds. The latter almost always track the market to some degree. Individual stocks, on the other hand, are far less likely to do so. In this respect, industry and sector funds perform more like individual stocks. Consequently, it is dangerous to use the usual criteria - prior track record and management ability - when evaluating sector funds. (The exception is when you are comparing historic performance of active managers working in the same sector.)
To illustrate: Consider the fate of the majority of investors who bought Fidelity Select Biotechnology in 1991. Launched in late 1985. Fidelity Biotech performed poorly until 1989, when healthcare and biotech stocks took off. Fidelity Biotech rode the upswing to gains of 43.9% in 1989, 44.3% in 1990 and 99.0% in 1991. Investors responded by opening new accounts and flooding the fund with assets. During the second half of 1991 alone, investors poured $663 million into the fund, which ended that year with $1.1 billion in assets and 118,000 shareholders.
Unfortunately, 1991 proved to be the top, as biotech stocks began a major multiyear correction. Fidelity Biotech lost 26.2% in the next three years and ranked 3,574th among all funds in 1994. Yet, its shareholder list never fell below 83,000 - a decline of only 25,000. Most investors bought too late and either sold too late or not at all.
Once a sector fund's stocks fall out of favor, the manager has few tactics for stemming the fund's losses. Stellar company selection within the sector will not save the day. Unlike diversified funds, the sector fund's manager can't adjust by switching sectors. The manager could sell stocks to raise cash, but they rarely do. When you buy a diversified fund, you are really buying the manager's expertise. But when you buy a sector fund, you are doing so because you want to own the stocks in that sector.
This means you should develop your own assessment of an industry's potential for appreciation before you buy a sector fund representing that industry. If you don't believe in the potential of the industry, stay away from its sector funds!
Even if you are attracted to a given sector, limit your entire portfolio exposure to 5% to 10% greater than a market weighting and don't hesitate to switch to another sector or a money fund when your sector's move is over. And be careful not to buy after a big bull move: if you buy at its conclusion, you might get clocked."
Editor's Note: The No-Load Fund Investor has just published a brand-new, completely updated 16-page Fund Family Directory to provide you with detailed contact information for every fund group recommended or listed in the No-Load Fund Investor. The Fund Family Directory includes addresses, phone numbers and websites for a total of 145 fund groups. Together, they account for almost every significant no-load fund sold in America today. (There is no information on individual funds.)
Well-designed, up-to-date and easy to use, The Fund Family Directory is a valuable tool for turning recommendations and strategies into timely action without having to search for fund-group contact information. It costs $10 and may be ordered with your subscription renewal or separately.
THE INTELLIGENT FUND INVESTOR
26106 Tallwood Dr., North Olmsted, OH 44070. z
Monthly, 1 year, $179.
Dr. Gary Harloff: "We believe the big move, starting October 2002, is nearly over and it is now a market of funds. We see sector rotation out of high tech. For several weeks of the four weeks, the Nasdaq closed lower. Gold has continued to shine as the U.S. dollar has gone lower. Other areas helped by lower U.S. dollar are: Europe and Energy. Another sign of a changing market is that "style" value favors growth. With these many signs of rotation, it is time to move out of index funds into specific funds.
This month we like areas including: gold (Profunds precious metals, PMPIX, and USGLobal Gold USERX), Energy (Fidelity Sel Natural Gas, FSNGX), European (Icon South Europe, ICSEX, Rydex large Cap Europe, RYEUX), Health (Fidelity Select Medical Delivery, FSHCX), and industrial (Fidelity Select Industrial, FSDPX) funds. As the equity recovery ages, large stocks will be stronger than small stocks.
Our timing signals are bullish for: S&P500, NDX, XAU, and bond yields (lower bond prices)."
ALL STAR FUND TRADER
P.O. Box 20347, Austin, TX 78720.
Monthly, 1 year, $249.
Ron Rowland: "Not counting the original settlement with Canary Capital Partners, Security Trust of Phoenix is the first company that has been ordered to shut its doors and dissolve its business as a result of the complaints filed by Eliot Spitzer. To be sure, the actions of Security Trust have been among the most egregious revealed so far, but we doubt that it will be the last company to fall. Given that corporate founders have been at the center of alleged misdeeds at Strong and PBHG, we can't help but wonder about the continuing viability of those management firms. At the very least, we expect the names of tainted fund management companies to start disappearing from fund names.
If it seems like there has been a never-ending parade of scandals within the financial services sector over the past few years, your mind has not been playing tricks on you. Historically, finger pointing and widespread allegations follow the bursting of a financial bubble, and this one is no exception. The following scandal list (and examples) is by no means complete, and in many cases the examples are "alleged" perpetrators, not convicted ones; bogus analyst recommendations (Grubman, Meeker), fictitious accounting (Enron, Worldcom, Arthur Andersen), insider trading (Martha Stewart), IPO allocations (Quattrone), corporate looting (Tyco), corporate governance (NYSE/Grasso), late trading of mutual funds (Security Trust, Bank of America), special trading arrangements (Janus, Alliance), insider trading of funds (Putnam, Strong PBHG), fictitious accounts to bypass fund timing restrictions (Prudential), obstructing investigations (Alger), unregistered tax-shelters (KPMG), failure to deliver breakpoint discounts (Morgan Stanley, American Express), and more.
The underlying problem in each and every one of these examples is greed. Pure and simple. Contrary to what Gordon Gekko preaches, we believe that this is a fine example of where greed is not good."
EQUITY FUND OUTLOOK
P.O. Box 76, Boston, MA 02117. Monthly,
1 year, $139. www.equityfundoutlook.com.
Seasonality cycle favorable until April
Thurman Smith: "The annual seasonality cycle is favorable until April, the presidential election and decennial cycles are moderately favorable.
Don't let news stories about fund scandals keep you from being fully engaged in taking advantage of the best managed funds for your objectives. The biggest question is, as always, will a well chosen fund be likely to make more money than you would with the same exertion of time and fees with another investment approach? Even where the actions we have been hearing about may have shaved pennies here and there, the main force behind net returns is investment performance. Strong performance is the ultimate dynamic for a good net return and can make up for a lot that is not perfect with a fund or its sponsor.
As for the fund shops under review of regulators, you can bet that going forward they are going to be cleaner operations, with so many eyes on them."
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