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How Sector Portfolios Fit Into the Broad View

January 18, 1998|RUSS WILES | Russ Wiles is a mutual fund columnist for The Times

Sector funds are enjoying a growth spurt.

With relatively little fanfare, the number of health-care, natural resources, technology, telecommunications and financial funds has more than doubled over the last three years, and the number of real estate funds has quadrupled.

What's driving the trend is respectable performance as well as a desire on the part of more investors to add a specialized product to their portfolios.

Sector funds by definition invest in stocks within a single industry, so by themselves they can be quite risky. Gold funds are the classic example. These have lost about 28% of their value on average over the last 10 years, entirely missing out on a decade of robust stock market gains.

Another problem is that sector funds frequently attract market timers, including traders who follow buy and sell signals from various investment newsletters. Sector funds sometimes see their assets grow or shrink dramatically depending on whether an industry is in or out of favor. Such turmoil can drive up shareholder-borne expenses and cause other performance-eroding disruptions.

The Fidelity Select Consumer Industries Portfolio, to cite an example, swelled from $8 million in assets in 1994 to $62 million in 1995, only to fall back to $17 million the next year. In each of those years, the fund lagged the Standard & Poor's 500 index by at least 8 percentage points. It charges about 2.3% in yearly expenses--high by industry standards.

These drawbacks help explain why sector funds' reputation is lukewarm. All told, they account for just 5% of the $2 trillion invested in all stock funds, reports research firm Lipper Analytical Services in Summit, N.J.

However, sector funds do offer advantages to investors savvy enough to exploit them.

"As investors have become more sophisticated over the last few years, some have looked for more specialized products," said Laura Parsons, a spokeswoman for Invesco Funds, a Denver company with 12 sector portfolios.

When investors bet on the right industries, the gains can be sizable: 21 of the 25 top-performing stock funds for 1997's fourth quarter were sector funds, according to Lipper. So were 10 of the top 25 funds for all of '97, 15 of the top 25 over the last five years, and 17 of the top 25 over the last decade. As for periods of 15 years or more, few sector funds have been around that long.

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The big enthusiasm for sector investing came in the mid-1980s, as the bull market was gathering steam. Fidelity Investments of Boston unveiled more than two dozen industry-specific Select funds within a three-year period, and many other fund groups began to add sector funds around that time.

Most investors use sector funds sparingly. However, you could build a decent portfolio composed of nothing but. A late-1995 study by fund tracker Morningstar Inc. of Chicago found that a portfolio of 10 sector funds chosen to reflect industry weightings in the Standard & Poor's 500 handily beat the performance of the typical mainstream stock fund over the previous decade.

"When combined intelligently, they [sector funds] actually can function effectively as a portfolio's core," Morningstar analyst Kurt Kunert wrote at the time. Sector fund managers "ought to be able to pick better stocks within an industry than . . . managers who have the entire stock market to wade through."

But if sector investing is gaining new popularity, few fund companies are planning to offer dozens of narrowly defined industry funds, as Fidelity does. Rather, fund groups are adding funds here and there within the dominant categories without trying to break new ground.

Said Steve Norwitz, a spokesman for T. Rowe Price Associates: "We have added funds in spots where we think they make sense to round out the family, but in general we've never been big fans of sector funds."

Russ Wiles is a mutual fund columnist for The Times. He can be reached by e-mail at russ.wiles @pni.com

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