Gold (which we technically classify as non-USA but we do have a separate code for it)Q. But aren't there some other types too?
A. Sure. There are a few leisure sector funds, and a few consumergoods/services funds, and so on, but not enough for us to make a separateclassification.
Q. OK, so back to the basic questions... are these suitable for the averageinvestor?
A. Probably not for the average investor, but OK for somewhat moresophisticated investors than the literally average mom & pop.
Q. Why so?
A. People have a hard time with risk. And people have been over-educated-in my judgment- that they are supposed to "buy and hold."
Q. And sectors rotate in and out of market leadership, right?
A. Exactly, and not usually gently! So if you buy sector funds or ETFs youneed to be prepared for greater-than-average fluctuation and you need tohave the discipline to sell them when the world changes. Technology wasgreat in 1998 to early 2000 but it has burned people badly since then. Ifyou are a firm buy-and-holder, you will get hurt when sector winners becomelosers. And if you have a hard time admitting when you make a mistake, youwill hold stubbornly and lose money.
Q. With all the recent new rules trying to prevent short-term trading, dousing sector mutual funds make sense any more?
A. That is certainly a very important question. You need to find out eachfund/family's rules -- what kind of penalty like 2% or whatever will yousuffer if you do decide to sell in less than 6 or 12 months? You may welldecide that buying an ETF makes more sense than owning a sector fund, forthat reason.
Q. How much money is there in sector funds these days?
A. All kinds of sector mutual funds combined have about $215 billiondollars. That's only about 5.4% of stock mutual funds in total. It's onlytwo-thirds the amount people have in Balanced funds and less than a thirdof what they have in World Equity funds.
Q. Which kinds have the most assets?
A. It's a neck-and-neck race, with health/bio and real estate each around$50 billion. Technology funds at their high had $185 billion but they arenow down to about $37 billion.
Q. What do you think is an appropriate allocation to sector funds?
A. In general, except for very aggressive investors who are nimble and/oractive and have strong opinions on market themes, I would not go past 10%.
Q. And how would you use them?
A. I think in two basic ways. First, there are sometimes obvious trendsthat you don't want to miss. If you think oil and gas are not done goingup, you would want more Natural Resources than a typical diversified mutualfund holds. So you'd add a few percent there to tilt your overall positionmore heavily. Or you could make up your own portfolio by selecting a fewsectors that are long-term winners. For example, health care and leisureand financial services grow faster than the economy as a whole. Real estatehas low correlation and pays a good yield, so you might add that in. But Iwould not want to ride gold- or oil- up and down for full cycles, as theseare mature industries.
Q. But owning just a few would give you a lot of volatility.
A. Definitely so. If you can stand the waves, those boats do travel fasterthan the overall market in the long haul. If you add technology to thosethree (HC, leisure, and FS), over the long term you probably average 2% or3% a year better than the S&P 500. Average, but with more fluctuation.
Q. So that's why you say maybe not a standard choice for the truly"average" investor.
A. Right. You have to be a disciplined contrarian, not a buy & holdbeliever, and be able to accept the above-average daily and monthlyvolatility.
Q. You mentioned ETFs a couple of times...
A. Right; they are a good way to go. And there are ETFs for some industrieswhere you may have no or few mutual funds. Plus you can trade them any timeof day and there are no early-redemption charges possible. And they havelower expense ratios.
Q. Where can people get more information?
A. On the funds, the LipperLeaders.com website. You can specify one sectorin the drop-down menu and compare performance, tax efficiency, consistency,expenses, and so on. You could look at Fidelity.com, since they have about40 sector or industry funds. Not a recommendation one way or the other! ForETFs, I'd probably go to ETFconnect.com or to the iShares.com (one brandonly) website, or to AmEx.com.
Q. Overall, long term, what are the results for sector funds?
A. Here are the 15-year compounded average-performance numbers (the samplesize is pretty small further back than that!) through June 30, 2005...
- Financial Services +16.4%
- Health Care/Biotechnology +13.8
- Natural Resources +10.9 biased upward by recent success!
- Real Estate (mainly REITs) +12.4 ditto
- Science & Technology +12.3 even with all the post-mania damage included
- Telecommunications + 8.7
- Utilities + 9.7
- Gold + 2.8 even after their big run a couple of years back
These are NOT recommendations, but general ideas.Q: Thanks, Don!
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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).
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