Focusing on mutual funds that are faring badly in the short term but have good long-term records can uncover bargain buys
An old method for hunting bargains in mutual funds points to a couple of interesting possibilities right now.
Call it the 'long-term heroes, short-term zeros' system, or 'get 'em while they're cold.' It focuses on funds that boast good records over the past five, 10 or 20 years but have lately been lagging. If all goes well, the aim is to buy into something solid without having to pay top dollar.
Glancing over a current fund performance table, you can quickly spot two categories of specialised stock funds fitting that description ' healthcare and finance sector funds.
Last I looked, the 175 or so health and biotechnology funds tracked by Bloomberg averaged a 7.2% loss so far in 2002, and were down 6.6% over the past 12 months. Over the last five years, though, the health-care funds still boast an average annual return of 13.3%, which trounces the 6.1% average for all stock funds.
Finance funds tell a similar story. Bloomberg data show 112 financial services funds, even after a recent rally, up a modest 5.3% in the past 12 months ' less than half their 11.2% average annual return over the last five years.
What we hope to find using this kind of guideline is a strong candidate for purchase at a weak moment ' the rough equivalent of a racehorse that ran poorly the last time out but generally outclasses its competition. The risk is that time or injuries have caught up with our runner, dimming its chances of regaining former glory.
Most of the time, sector funds are a sketchy proposition for investors of the long-term, buy-and-hold school ' which I argue is where most individual investors want to be enrolled. Sector funds don't provide the kind of diversification across the economic spectrum that stands as one of the most important reasons to buy funds.
But health and finance funds have been big long-term winners, positioned as they are in areas of the economy that benefit from powerful trends in society and demographics.
The better health care gets, extending human life spans, the stronger demand for additional health care seems to grow. The more prosperous a society gets, the more financial services these longer-lived people require ' in particular, saving for an old age much longer than former generations even dreamed about.
In the top 25 five-year performers among stock funds of all kinds we find both the Pimco RCM Global Healthcare Fund, which has averaged a 24.6% annual return over that stretch, and the Vanguard Health Care Fund, up an annualised 22.3% (disclosure note: while I own no health-care funds, I do have a modest stock investment in the pharmaceutical company GlaxoSmithKline).
Financial-services funds, less spectacular, have still produced the likes of Fidelity Select Brokerage & Investment Management, with a five-year annualised gain of 18.8%; T Rowe Price Financial Services, up 15.2%, and AIM Global Financial Services Class A shares, up 14.4%.
Both industries have some issues at present. Many financial companies have thrived on a drop in declining interest rates over the past couple of decades, which some think has about run its course.
Health-care companies ' in particular pharmaceutical manufacturers ' are under pressure again from critics who say their prices are too high.
The last time drug producers faced a big challenge to their pricing power ' amid a 'health-care reform' drive in the early years of the Clinton presidency ' turned out to be a fine time to buy. From the end of 1994 through the end of 1998, according to my Bloomberg, Vanguard Health Care averaged a 33.2% annual gain.
Can we be certain that events will follow the same script this time around? Of course not. But legislators and regulators are under considerable constraints in both these areas.
When you mess with people's money, after all, you're getting into something that's very important to them. One of the few worldly things they might rank ahead of their finances would be their health.
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