With Narrow Focus, Sector Funds Sink or Soar

Have a hunch one industry will outperform others this year? Sector funds allow you to invest in it - reaping risks or rewards

Sector funds appeal to the stock picker in you.

They're for bold investors, ready to follow a hunch, perhaps that tech stocks will triumph while bank stocks will tank.

But instead of actually picking a single technology stock, you can pick experts, who spend most of their waking moments finding the best technology companies

Those experts manage sector funds in technology - or gold or banks or retailing, etc.

So if you have $1,000 to invest, you can hold your breath and hope that 10 shares of Microsoft (at about $100 per share) will do the trick.

Or you can buy 33 shares of Invesco Strategic Technology fund ($29.66 per share), managed by veteran Dan Leonard, and own a piece of 88 different companies, Microsoft among them.

This can be rewarding or risky.

Sticking with our example, if you said "Dan's the man" at the beginning of 1996, you would have made almost 22 percent for the year.

If you fell in love with Dan on Jan. 1, 1997, you'd be thinking "Let's just be friends" right about now. He's off by about 4.5 percent.

Some sector will always outperform the rest of the mutual fund industry.

The key is picking the right one and a willingness to lose the safety of diversification offered by broader-based funds.

When you invest in a typical fund, you are buying the expertise of a manager, says Sheldon Jacobs, editor of the No-Load Fund Investor, a newsletter in Irvington-on-Hudson, N.Y.

With a sector fund, you are really buying into the industry. Choose the wrong industry, and even having superstar Peter Lynch can't help.

Sectors can be treacherously cyclical.

Industrial groupings rise and fall, depending on the economy, he says.

Consider, again, technology.

Many analysts see this sector as a long-term leader, but this year it's down 7.4 percent through March 18 (see chart, below, left).

So do your homework.

One way to spread the risk is with a portfolio of sector funds. That lets you diversify, while excluding industries you don't like.

This year, the hottest sector is financial services, up 8.9 percent through February, says Annette Larson at Morningstar Inc., a fund-rating service in Chicago. The Standard & Poor's 500 stock index, by contrast was up 6.76 percent for that period.

Some Wall Street analysts see financial funds continuing to gain through industry mergers, cost-cutting at banks, and relative stability in the bond market.

Higher interest rates, however, could slice into profits for the group, especially at insurance firms. And in recent days financial stocks have sagged.

Four other top sectors, for the year through February, are precious metals, up 6.37 percent; health care, up 5.62 percent; specialty sectors, such as leisure and entertainment, up 2.45 percent; and real estate, up 2.02 percent, according to Morningstar.

Looking ahead, the retail sector seems ready to break out, says Robert Buckman, portfolio manager at Brandywine Asset Management, an investment firm in Wilmington, Del.

Department-store, apparel, and drugstore stocks look strong.

The sector may also be a good defensive play in case of a market downturn, he notes.

Precious-metal funds are considered high risk.

Gold funds on average have stayed flat for the year, in part because inflation, which often drives gold prices higher, has been modest globally.

Still, some funds, such as Pioneer Gold (see chart, left) have performed well.

Another sector some investors play as an inflation hedge, natural-resource funds, surged late last year. Now the group may be cresting, Ms. Larson says.

Other slow sectors lately include heavy industry, consumer companies, and electronics.

But if many sectors are cool at present, the gains can be spectacular.

Many of the hot performers last year were sector funds, in areas such as electronics, real estate, and natural resources.

First Financial Fund, which invests in financial stocks, has more than doubled in three years.

Since 1990 the fund, which is a closed-end fund trading on the New York Stock Exchange, is up almost 1,000 percent.

A closed-end fund, unlike most mutual funds, has a limited number of shares available to investors. Your broker will buy it on a stock exchange, rather than from the fund company.

If you want to invest in sector funds, where do you start?

Lots of fund families offer them, but Fidelity Investments and Invesco are among the best-known.

Invesco, based in Denver, publishes a helpful guide to sector investing. To get a free copy of "The Wise Way to Invest in Sector Funds," call 800-610-9337.