Some favorites to consider among specialty-financial funds

Dollars & Sense

July 21, 2002|By Scott Cooley | Scott Cooley,MORNINGSTAR.COM

For a look at the bifurcated nature of the specialty-financial group's returns, just look at the world through the eyes of Jim Schmidt.

Schmidt is the skipper of two funds in the category, John Hancock Financial Industries and John Hancock Regional Bank. At one, he looks like a genius. At the other, he looks, well, not so smart.

Hancock Regional Bank, as its name suggests, focuses on banks, which have benefited from a favorable interest-rate environment and a recovering economy. That fund is a category leader for the year to date. At Hancock Financial Industries, by contrast, Schmidt spreads his assets across the financial-services subsectors. He therefore has exposure to very hard-hit parts of the market, including brokerages. That fund ranks near the bottom of the category so far this year.

We're not inclined to chase returns by stuffing our specialty-financial picks' list with funds that focus on regional banks or savings and loans, which have also performed well. Why not? Investors may recall that in the late 1990s, the worst-performing funds were those with a lot of bank and thrift exposure. By contrast, the group's top-performing funds were those with a lot of equity-market exposure, including Fidelity Select Brokerage & Investment, which has tumbled in recent years. Chasing returns would hurt investors then, and it would probably hurt them now.

When we devised this list, we focused on funds with experienced managers and broadly diversified portfolios. At nearly any given time, narrowly focused offerings will pace the category. But we think our stable of managers, including Davis Financial Fund's Chris Davis and Ken Feinberg, will deliver solid long-term results. One pick we're concerned about is Invesco Financial Services. It retains its broad diversification but changed managers this year. We'll be monitoring manager Joe Skornicka closely in the coming months.

Davis Financial A: This fund's exposure to growth financials that have faltered hurt it in 2001 and early 2002, as did management's tendency to buy some nonfinancials stocks, including Tyco International, which crumbled after analysts raised questions about its accounting practices. But over time, Davis and Feinberg have produced some of the category's best returns. And in general, those nonfinancials picks have lowered the fund's volatility. Overall, this remains a compelling offering.

Invesco Financial Services Inv: There are a few elements of uncertainty here. Lead manager Jeff Morris stepped down in February, handing the reins to Skornicka, who lacks Morris' long track record. Moreover, the fund is coming off a bad year. But we still think management's strategy, which includes focusing on market leaders that are increasing their revenues and earnings at a solid pace, is sensible. In addition to having one of the category's lowest expense ratios, this fund offers competitive longer-term returns and exposure to some beaten-down, growth-oriented parts of the market that may be poised for a rebound.

John Hancock Financial Industries A: This fund has suffered mightily since the beginning of last year, but we still like it. Schmidt's insurance and brokerage picks have stumbled over the past year. But we still think his investment thesis - that there is likely to be a wave of mergers among banks, brokerages and insurers - makes sense. Schmidt is one of the most experienced investors in the category, and he has plenty of analyst support.

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