Investors Continue to Treat
Sector Funds as Toxic Bets
By IAN MCDONALD
THE WALL STREET JOURNAL ONLINE
Not too long ago, fund investors lusted for sector funds. Now they can't run from them fast
enough.
Most candy-colored asset allocation pie charts prescribe putting no more than 10% of a
long-term stock-fund portfolio in sector funds, which primarily own stocks of companies in a
given sector like health care or sub-sector like biotechnology. The reason for caution is that
betting the farm on one sliver of the market, as opposed to holding stocks of companies in a
range of industries, is a well-known recipe for volatility and sleepless nights.
Even so, as the market -- and investor confidence -- soared, individuals sprinted to sector
funds. A record-setting 25 cents of every dollar sunk into U.S. stock funds in 1999 and
2000 went into a technology or telecommunications fund, according to data from Boston
fund consultancy Financial Research Corp.
But that big bet went badly awry. Telecommunications and technology funds have fallen so
hard that the 1999 gains have evaporated. And now sector funds are knee-deep in net
redemptions for the first time in more than a decade.
Today bond and vanilla index funds crowd the bestseller list. The sudden sea change
illustrates the depth of our new reluctance to choose an active fund manager, let alone the
next hot sector.
"These shifts indicate, yes, people are a lot more sober," says Russ Kinnel, director of fund
research at Chicago research house Morningstar. "They also indicate that maybe the people
who stuck with index funds and other sober strategies are the ones who still have money to
keep investing."
It's easy to see why so many jumped on the tech- and sector-fund bandwagon. After all, in
1999 the average tech fund rang up a 136% gain, compared to 21% for the S&P 500. Tech
funds gobbled up $32.9 billion that year and $49 billion in 2000. Their previous record was
a $4.4 billion intake in 1995.
Emboldened by eye-popping gains, investors stuffed $68.5 billion into sector funds, after
redemptions, in 2000. That's more than all U.S. stock funds took in, after redemptions,
during 1988, 1989 and 1990 combined. Fund companies caught tech fever too, scrambling
to get a piece of the action. The number of tech funds jumped from 51 at the start of 1999
to 156 today.
"People were just chasing performance, buying a big number," says Geoff Bobroff, a fund consultant based in East
Greenwich, RI. "Now we know all those funds were driven by [companies with] fraudulent earnings and hot IPOs, most of
which have blown up."
With that lesson learned, and tech funds averaging a 10% annual loss over the past three years, investors' tastes have shifted
dramatically. Last year redemptions from sector funds outpaced investments by more than $11 billion. The last time sector
funds finished in the red was 1988, when they bled $551 million. After the first 60 days of this year, they were already in the
red by $483 million.
In 2001 and the first two months of this year, index-fund giant Vanguard was the nation's top-selling fund firm. The firm's 500
Index, Total Bond Market Index and Total Stock Market Index funds are all among the top-20 selling funds this year, as they
were in 2001. The top-selling fund last year and so far this year, is the PIMCO Total Return fund, a bond portfolio run by Bill
Gross. Overall, bond funds netted nearly $76 billion last year, more than double the cash flows to stock funds.
It's hard to argue with rattled investor's flight to diversified and low-cost stock index funds, though some would say they run
the risk of being too cautious, or simply chasing performance again, when they flood bond funds with cash.
Count fund marketers who touted white-hot returns in 1999 and early 2000 among that crowd.
"I think there is a certain loss of confidence," says Keith Hartstein, an executive vice president in charge of sales and
marketing at John Hancock Funds. "Now everybody wants to put all their money in the most secure [funds] they can, but
that's probably just as wrong as putting all your money in the most aggressive place you can."
Mr. Hartstein has witnessed, firsthand, a unique byproduct of the past two years' drubbing: a reluctance to buy shares of a
sector fund, even if it's beating the market. The John Hancock Regional Bank fund, up 17% over the past 12 months, has
topped the S&P 500 in each of the past two calendar years, according to Chicago research house Morningstar. Still, the fund
has been mired in net redemptions over the past two years.
Despite being up 13%, on average, over the past 12 months, financial sector funds finished last year in net redemptions have
started 2002 the same way.
It's common for investors to flock to the style or sector of the day and retreat if those moves lead to big losses. But one might
argue that a middle ground between big bets on hot sectors and no bets on hot sectors makes more sense. For many, the
boldest approach might be too volatile and the meekest too plodding.
A high-octane portfolio with half its money in the average large-cap growth fund and the rest split between the average
technology and telecommunications funds would've averaged an 11% annual gain in the ten years ending March 1. It's worst
12-month loss would've been 56%.
A comparatively placid portfolio with half it's money in the Vanguard 500 Index fund and the rest in the firm's Total Bond
Market Index fund would've gained 10% annually, on average over the past decade. Its worst year along the way was a 9%
fall.
There is, of course, a middle ground, where sector funds and bonds play a more modest role. That said, the market's choppy
waters makes it look pretty racy too. A portfolio with 80% of its money in Vanguard's 500 Index fund and the rest split
between the Total Bond Market Index fund and the average tech fund would've run up a 13% annualized gain over the past
ten years.
Its worst one-year loss, a 30% tumble, isn't easily dismissed, though it's not much worse than the S&P 500's.
Updated April 8, 2002 8:32 p.m. EDT |
