Mutual Funds
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Time to take a profit on finance funds
They've had a grand run, but other groups are likely to outperform now. If you want to hang on for the long term, though, here are two funds to try.
By Timothy Middleton
Decades of declining inflation and business-friendly government have made financial services the best sector in which to invest. In the 15 years ended April 30, the groups annual average return of 15.4% edged out health care by 0.2% and technology by 1.8%.
It was also the place to weather the bear market in stocks, advancing 6.9% in each of the last three years, while health care and especially technology took baths. This year, it has continued to perform admirably, jumping 14.7% as of June 4.
But the group's glory days are ebbing. Instead of defensive areas such as finance, "think (of groups that benefit) early in the economic cycle; that favors technology, which of course has been leading the parade," says Al Goldman, chief market strategist of A.G. Edwards. Health care is another sector he expects to outperform finance in coming years.
If you own the group, its time to take profits. Aggressive sector rotators are abandoning it entirely for tech and biotech. If you dont own the group, but want to -- because its long-term fundamentals remain strong -- its time to consider only funds that are well-diversified across the often-volatile industries that make up the sector.
I would steer investors away from the smaller, quirkier kinds of funds. You should get broad exposure, says Brian Portnoy, who covers many financial funds for Morningstar.
Looking long term
The long-term argument in favor of financial services remains in place. Americans are wealthier than they have ever been, and their appetite for financial products, while dulled in the bear market, will grow as demographics carry the population beyond the consumption phase to the time for saving and investing.
Where can you get leverage to the improving economy? asks Michael Holton, manager of T. Rowe Price Financial Services (PRISX). Through brokerage firms and asset managers, he replies, as well as money-center banks, consumer-finance companies and mortgage lenders.
One of the reasons the financial-services sector has been an excellent place to invest is that it comprises many different industries powered by different dynamics. Standard & Poors Corp. counts 10 of them: banks, consumer finance, diversified financial services, insurance brokers, life and health insurance, multi-line insurance, multi-sector holdings, property and casualty insurance, real estate investment trusts and reinsurance.
Together they accounted for 20.4% of the markets total capitalization in April. That's close to the record high of 21% set last August, and it means investors value the group much more than they have in times past. In 1980, the sector accounted for less than 5% of the market, and only 7.5% at the end of 1990.
This is a banner time for the group, says Richard Peterson, chief market strategist for Thomson Financial. Banks can borrow from the Federal Reserve at 1.25% and easily charge customers 4% on high-quality credits. Mortgage refinancings continue to set records. Credit-card companies are the U.S. Postal Services largest customers, and money-management companies are attracting fresh assets in a suddenly buoyant stock market.
The best positioned
The two mutual funds best positioned to benefit from these trends are T. Rowe Price Financial Services and Fidelity Select Financial Services (FIDSX). The former exploits the sober, value-tinged analysis that permeates all T. Rowe funds. The latter benefits from Fidelitys huge research department, which operates five financial-industry funds as well as the diversified sector fund.
What they have in common is distinguished stock-picking records: Each consistently ranks in the top quarter of its peers in performance. They do it by successfully rotating among the strongest industries within their sector to deliver the steadiest returns.
Currently, they are similarly positioned, stressing big banks, asset managers and insurers. Both funds, for instance, have Citigroup (C, news, msgs) and Bank of America (BAC, news, msgs) among their top five holdings.
With such strong fundamentals behind it, the financial services sector is a candidate for profit-taking only because its performance relative to other groups is likely to lag over the coming several years.
Sectors routinely surrender leadership to each other. Information technology went from a peak of 34.5% of the market capitalization in August 2000 to a trough of 7.5% in December. Health care went from a mere 3.9% of market cap in the spring of 1977 to a peak of 15.7% in March. Energy collapsed from 29.2% of the market in 1980 to 4.9% in January 1999.
Dump it
For contrarians and aggressive sector rotators, financial services are a candidate for outright sale because they're trading so close to their peak. Steve Leuthold, manager of Leuthold Core Investment (LCORX), which practices sector rotation, is entirely out of the group.
In a report to investors, he wrote: The financial sector weighting is not expected to fall back to its long-term median (9.3%), but a retreat back to the 1990-to-date median of 15% is expected in the next several years. The decline will be led by a combination of fundamental problems and better performance by most other sectors, including tech and telecom.
In my personal portfolio, I sold my financial services funds in 1999, when I was convinced they were running out of gas in an ebullient economy. Foolishly, I didn't buy them in 2000, when it became clear my premise was false. Lazily, I still havent gotten around to it.
Now, Im in no hurry. Its a great group, but not as appealing right now as technology and health care, my two other favorite sectors. I may end up kicking myself -- Im a terrible market timer -- but when I buy, it will likely be the Price or the Fidelity fund.
What they're buying
On the rebound: T. Rowes Holton likes the 4% yield hes getting on J.P. Morgan Chase (JPM, news, msgs), as well as the fact the company is benefiting from a number of different trends converging at the same time. The corporate lending business is improving, retail banking and mortgages are strong, and investment banking is crawling out of its bear-market black hole.
A successful merger: He also likes U.S. Bancorp (USB, news, msgs), representing the merger of Firstar and U.S. Bank. They have above-tier top-line growth due to their focus on selling, and a better business mix than a lot of banks, he says. Credit quality is improving. Hes expecting 13% to 15% growth in earnings per share.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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