“You would have made money during the Depression if you dollar cost averaged through the ’30s,” he said. “A small fortune starts as a small portion compounded over time.”
NEW YORK — Sector investing can look deceptively easy.
For instance, Morningstar Inc. tracks more than 200 real estate funds and almost all are up double-digits for the year. Easy money, right?
Maybe not.
“In general, I’m not a big fan of the sector funds,” said Christine Benz, director of fund analysis at Morningstar. “They duplicate the exposure you get from a diversified fund. The difference is you don’t have much latitude if the sector falls from favor.”
While a diverse fund offers protection, a sector fund offers pure exposure, which can be great while a sector is on a tear, but miserable if it’s not. Information technology stocks were winners if you got out at the exact right moment in 2000, but the sector was down 2 percent for the year as of Aug. 25, while the Standard & Poor’s 500 was up 7.47 percent.
On Friday, four of the worst performing mutual funds of the 18,766 Morningstar ranks were sector funds that focus on Japanese stocks. When you take such a thin slice of the world’s equity market, timing is everything. For instance, AIM Japan A, whose front load is 5.5 percent, has been on a steep downward track since it opened earlier this year.
And sector funds tend to charge heftier fees or bigger loads. “It’s been a convention in the fund industry that funds can charge more if they’re sector funds,” Benz says. “In a lot of ways, that defies logic. You need to hire fewer researchers to analyze a single sector than a diversified fund that looks at multiple sectors.”
Historically, investors haven’t been smart about sector investing, piling in when the sector was near its highest prices and bailing out at the bottom, said Charles Biderman, chief executive officer of TrimTabs Investment.
For instance, investors poured $90 billion into global equity funds in the first four months of 2006, right before they slumped, according to TrimTabs.
That brings us back to the real estate funds. Investors put $193 million into real estate funds in the five days ending Aug. 23, which followed the $170 million flow into the funds the week before. For the year, they’ve put $3.48 billion into the funds, which have aggregate assets of $57 billion, according to Bank of America.
Real estate funds are slightly different from other sectors. For one, they usually pay a handsome dividend. Second, many diversified mutual funds have no exposure to real estate. But Benz cautions that no more than 5 percent to 10 percent of your portfolio should go in to the funds and warns that investors looking for income should not use them as a substitute for bond funds, since they don’t offer price stability of the underlying asset.
Some investors may be learning the sector lesson. In the last two weeks, investors have shaved their holdings in winning energy funds. Investors pulled $81 million out of energy funds during the five days ending Aug. 23, according to Bank of America. And they had pulled another $85 million out of the $20 billion sector during the five days before that.
That still leaves investors with a huge position, exactly the type of bet that makes Biderman nervous.
Instead of sectors, he recommends dollar cost averaging, which means making regular investments, into a broad index fund.
“You would have made money during the Depression if you dollar cost averaged through the ’30s,” he said. “A small fortune starts as a small portion compounded over time.”