Hurting sectors of economy may appeal to nervy investor

Your Funds

Dollars & Sense

September 30, 2001|By CHARLES JAFFE

WITHIN DAYS of the terrorist attacks on America, analysts were talking about which sectors of the economy would be hurt the most.

For an investor looking to properly use sector funds to boost his or her portfolio, those hard-hit areas immediately became potential buys.

That runs against intuition, but so does most of the strategy involved in successful sector investing. It's why so few people can do it well, and why it's not for anyone with a weak stomach in times like these.

"Sector investing is an extraordinarily difficult game to play and win, even for professionals," says Roger Gibson of Gibson Capital Management in Pittsburgh. "Ordinary investors will be drawn to whatever sector has done well and will avoid whatever sector has done poorly, which tends to put you in the wrong place at just the wrong time.

"It's something to be very careful with, and I don't think most investors are."

Sector funds are designed to invest in specific industries or portions of the economy. They can be as narrow as a single business, such as airlines, or as broadly defined as technology or financial services.

Where an ordinary growth fund can move large chunks of money from one industry to another, sector funds are largely limited to the arena they choose to play in, regardless of whether their chosen assets are in favor with the market. By concentrating the portfolio, sector funds tend to be big winners during good times, and equally big losers during bad.

As a general rule, sector funds were designed to provide sophisticated investors with a tactical method for trying to beat the market, by being contrarian, defensive, hyper-aggressive and so on. Sector funds often play a role in market-timing strategies.

But because sector funds tend to swing from good to bad with the economic times, investors who are attracted to good-time performance usually wind up with bad-time numbers.

Through August, for example, Morningstar Inc. data showed that the fund sector with the most money invested - technology - had the biggest losses, while the sector with the least money invested, precious metals, has been the biggest winner.

Most of the investors drawn into technology funds made the move after 1999, a year in which many of the tech funds posted triple-digit gains.

What truly makes the sector picture murky now is the impending conflict and the aftershocks from the terrorist attacks.

The economy clearly was in a contraction mode before the attacks, with many analysts calling for recovery to start early next year.

Typically, late in a contraction cycle, financial services firms and stocks boosted by consumer spending tend to do well. When the contraction moves into a recovery and expansion mode, technology stocks and the transportation sector tend to come to the fore.

In other words, the industries most damaged by the market's reaction to the attacks are the very sectors whose heating will signal that the economy is about to turn around.

But the impact of the attacks effectively was a reversing of the cycle - a do-over - setting the economy backward from the middle of a decline to the start of a decline, lengthening the recovery.

If that sounds confusing to you, then chances are you don't want to be betting on sector funds, and should stick instead with more general purpose funds where the manager can read the trends and react to them.

"Generally, investors are not good at sectors, getting in at peaks after a sector gets hot," says Craig T. Callahan, chief investment officer for the ICON funds, a small Englewood, Colo.-based fund family that includes sector offerings.

"There are opportunities - our valuation readings show this to be the fourth-best buying opportunity of the last two decades - but the best bargains are in the industries most people don't want to be in right now."

Most experts recommend committing no more than 15 percent to 20 percent of a portfolio, divided between different parts of the economy.

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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