Despite all the excitement generated by technology stocks this year, mutual funds that target those shares are playing second fiddle to a much less flashy fund sector: financial services.
Through last week, the average financial services stock mutual fund was up 19.3% year-to-date, compared to a 16.8% gain for the average technology stock fund, according to Lipper Analytical Services Inc.
What's more, the five-year track record of financial services funds, measured through the first quarter, was the best of the 19 specialty fund groups tracked by Lipper. Owners of financial services funds earned 143% on their money, on average, in that five-year period, more than double the 70% earned by the average general stock fund.
The tailwind for the financial sector funds for most of the past five years and again this year has been generated by falling interest rates, which are almost always a boon for the bank and S&L stocks that naturally dominate most financial funds.
Sliding rates typically translate into a wider spread between what banks earn on their loans and what they pay for deposits, because loan rates tend to fall much more slowly than deposit rates.
Between 1990 and 1993, that spread, or "net interest margin," jumped from 4.15% to 4.75% for a universe of major banks followed by Donaldson, Lufkin & Jenrette Securities. Combined with a recovering economy that sharply reduced banks' bad loan write-offs, the average return on assets within the DLJ bank universe more than doubled from 0.60% in 1991 to just above 1.2% in 1993.
But the spectacular surge in bank shares that accompanied that financial bonanza ended in 1994, when the Federal Reserve Board began to boost short-term interest rates. In the fourth quarter--as interest rates peaked--heavy selling slammed the bank stocks, driving the average financial services stock fund to a 5.7% loss for the quarter and a 2.7% loss for the full year.
Yet the widespread blow to bank earnings that some investors feared from higher rates failed to materialize in 1994. Instead, many banks' operating earnings rose 10% to 20% from 1993. And the gains continued in the first quarter: The median earnings rise for DLJ's bank universe was 9.8%.
Jim Schmidt, manager of the $950-million asset John Hancock Regional Bank stock fund in Boston, says the lesson over the past year and looking forward is that the industry's earnings "aren't as sensitive to interest-rate moves as people think," at least compared with recent history.
In part, that reduced rate sensitivity reflects banks' moves into a host of new businesses (managing mutual funds, for example) that produce steady fee income rather than more volatile interest income.
For 1995, Schmidt expects the average bank in his portfolio to show earnings growth of about 10%. While the economy has unquestionably slowed overall, loan growth has been relatively brisk at many banks, Schmidt notes.
That growth has been most pronounced in the Midwest and South, says Sam Marchese, manager of the Walnut Creek, Calif.-based SIFE Trust Fund, which owns mostly bank stocks. "We find that the central part of the country is very vibrant," he says. Tennessee bank stocks alone make up 8% of SIFE's $507 million in assets. Their rally has helped boost the fund 25.2% so far this year.
But after five years of strong gains, how much life is left in bank shares? Obviously, a serious whiff of recession could end their rally in a hurry, because investors' focus would turn to the inevitable rise in bad loans that would accompany an economic downturn. So buyers today have to believe that the economy isn't about to submerge.
On the other hand, the bank stocks' relatively low price-to-earnings ratios (Schmidt estimates that his average stock sells for 9.7 times estimated 1995 earnings) and high dividend yields offer value in an increasingly high-priced stock market.
Another ongoing attraction: The industry continues to consolidate at a rapid pace. Laws allowing full national interstate banking will take effect this fall, accelerating mergers.
That will also raise the risk level for banks that can't compete with ever-encroaching national giants. Indeed, one oft-heard argument against bank-industry investing is that many banks' businesses are under attack by all sorts of competitors (which is why banks are petitioning Congress for new powers). Still, Schmidt says, competitive worries aren't new. "And there's a lot of inertia that favors the banks and the [customer] relationships they already have," he notes.
For investors who want to make a broader bet on financial services, the Fidelity Select Financial Services fund owns banks, brokerages and insurers. For a narrower bet, the Fidelity Select Home Finance fund has traditionally (and quite profitably) focused on small S&Ls.
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Banking on Finance
The handful of mutual funds that focus on financial services stocks--those of banks, S&Ls, brokerages and insurance companies--have risen sharply this year and also boast hefty five-year gains.
Total inv. return: 5 yrs. thru 1995 ended 3/31 Fidelity Select Home Finance +27.7% +238.4% Fidelity Select Financial Svcs. +26.5% +141.2% SIFE Trust Fund +25.2% +147.4% Fidelity Select Regl. Banks +23.9% +162.4% Venture Adv.: Ret. Plan. Finl. A +23.7% NA John Hancock Regional Bank B +22.6% +168.1% PaineWebber Regional Financial A +19.7% +152.9% Invesco Strategic Financial +17.5% +160.7% Average general stock fund +13.0% +70.4%
NA: not available (fund didn't exist for entire period)
Source: Lipper Analytical Services