``These are aggressive investments, the kind you want to pay close attention to.'' It sounds as if Michael Hines, equity funds product manager at Fidelity Investments in Boston, is trying to scare investors away. Mr. Hines is in charge of marketing the Fidelity Select Portfolios, the group of 16 ``sector'' funds, each of which invests in specific industries.
In a way, he is trying to shoo some people away. To make money in a sector fund, it's up to the investor to decide which part of industry is -- or will be -- doing well and move in and out of these sectors as times change. ``People who go with these funds are the kind of people who follow stocks anyway,'' he says.
Sector funds have been one of the hottest performers among mutual funds this year. These funds limit themselves to specific market groups, like computers, utilities, health care, precious metals, or overseas companies. The overseas funds have done particularly well. While the Standard & Poor's 500 average was up 17.63 percent in the first nine months of the year, Fidelity's Overseas Fund was up 45.87 percent, making it the leader among all funds tracked by Lipper Analytical Services. Other Fidelity sect or funds, in health care and leisure, gained 33.19 and 30.29, respectively. Less lofty, but still respectable, was Vanguard's Service Fund, which gained 21.03 percent.
On the other hand, one of last year's hot funds, Fidelity's Select Technology, lost 10.4 percent and Vanguard's Special Technology Fund, though it did somewhat better, still lost 1.26 percent.
Mutual funds that invest in specific industries have been around since the 1930s. There were farm equipment and supply funds and steel funds, for instance. The idea fell into disfavor in the 1950s, although a few funds did continue with some concentration in the meantime, as in utilities, gold, and overseas stocks.
The latest rise in sector funds came four years ago when Fidelity introduced its Select Portfolio. Until this year, there were nine industry groups represented. In September, Fidelity added seven more. Other investment companies have weighed in with their own sector funds, including Financial Programs and Vanguard, with five each, and Franklin, Putnam, and United Services, with three each. In a few months, Fidelity is expected to add a few more to this selection.
In all, there are some 130 sector funds investing in electronics, gold, utilities, biotechnology, natural resources, and leisure activities, a category that can include everything from running shoes and toys to and gambling equipment companies.
And there are almost as many opinions about the investment wisdom of sector funds. The main criticism is that they violate a basic tenet of mutual fund management: Give people a widely diversified portfolio to cushion a decline in any one part of that portfolio.
``They scare me,'' says Richard Whitehead, a financial planner in Atlanta. ``People really need to keep an eye on them. I don't recommend them.''
``I've used a few, but you've got to watch them closely,'' says Gary Pittsford, a planner in Indianapolis. ``I've had clients make a lot of money in Fidelity's Select Technology. But they also lost money there. Some clients who know a certain industry have invested there. Doctors, for instance, have done well in the health-care funds.''
``I think you're going to see more and more of these in the next year,'' says Gerald Perritt, publisher of the Mutual Fund Letter in Chicago. ``They're great for the funds. They bring in a ton of money.'' Also, he said, having funds in different sectors ``makes sure there's always one of the company's funds at or near the top of the Lipper list every quarter.''
``But are they good for investors? Definitely not,'' Mr. Perritt counters. ``The reason for getting in a mutual fund is portfolio diversification.''
That diversification, he says, is supposed to put a minimum amount of risk on the selection of particular stocks, while putting more of the risk on overall market performance. In the average broad-based fund, he notes, 80 percent of the risk is related to the market, while 20 percent is tied to the stocks in the portfolio. In sector funds, it is almost the opposite, with only 30 percent of the risk tied to that part of the market and 70 percent related to the stocks the fund manager has selected.
Also, sector funds tend to promote frequent switching as investors try to anticipate -- or catch up with -- a movement of a particular sector. While a fund like one of Fidelity's will permit up to four free switches a year, these switches are not without other costs.
First, all of Fidelity's funds carry a 2 percent sales charge and a 1 percent redemption charge. Then, there's the possibility that an investor will make a wrong move, getting out of a sector prematurely, for example, and then going back in. The whipsawing effect of a few moves like this can more than erase any gains.
Finally, there's the question of taxes. Every move out of a sector fund, whether into another fund in the sector group or out of the investment company completely, constitutes what the tax people call a ``taxable event.'' If you've been in the sector less than six months, any profit will be subject to short-term capital gain taxes.
But for ``the more sophisticated investor who has already established an investment portfolio of growth and income funds and now wants an aggressive growth area, these can be useful,'' says Brian Mattes, vice-president of the Vanguard Group in Valley Forge, Pa. ``They should not be more than 10 percent of the overall portfolio. Sector funds should not be the foundation or bedrock of the portfolio because of their volatility.''
Mr. Mattes adds, howver, that an investor who thinks one industry -- technology, for instance -- is due for a rebound has a couple of options. He can buy one or two stocks in this area and wait to see if his picks were correct, or he can buy a sector fund to spread the risk and reduce the volatility.
But if an investor manages to pick one electronics stock that does well, he will do much better than if that stock was just one of several similar stocks in a mutual fund portfolio. Of course, he could also take bigger losses if that company's stock price took a swan dive.
To pick a stock, a sector, or a broad portfolio of growth stocks: It all depends on how well informed -- and brave -- an investor you are.