Mutual Fund Morning: Perfect 10s of Diversification

"Diversification" is the first word investors considering mutual funds are likely to hear from a financial adviser. And it makes sense. "Don't put all your eggs in one basket" is one of the earliest lessons in economics for many of us.

So which are the most diversified mutual funds? There are a number of ways to gauge diversification. One would be to simply count the number of stocks in a fund's portfolio. The problem with this is that no matter how many stocks a fund holds, its true diversification is limited if they all have similar characteristics. For example, in the late 1990s, a fund loaded solely with tech start-ups would likely have met an unfortunate fate no matter how many of these stocks it held.

So a potentially more useful measure of a fund's diversification would be the number of distinct sectors represented in its holdings. Using that logic, TheStreet.com Ratings has studied the dispersion of sectors within open-end stock funds. These are:

• Basic industries
• Capital goods and technology
• Consumer cyclicals
• Consumer non-cyclicals
• Energy
• Finance
• Miscellaneous
• Non-U.S.
• Transportation
• Utilities

In order to identify the most sector-diversified mutual funds, we set the following stringent criteria:

• Each of the 10 sectors above must be represented in the equity portion of the fund's portfolio.
• Every sector must represent at least 3% of the fund's equity holdings, thus insuring that the sector's weighting is of sufficient mass to influence the fund's performance.
• No one sector should represent more than 30% of a fund's equity holdings, as that would indicate a level of concentration that wouldn't be consistent with the concept of broad diversification.

The funds passing these rigorous constraints appear in the accompanying table. Multiclass funds are listed as a single entity, since their holdings are identical.

'Perfect 10s' of Sector Diversification' Holdings of Between 3% & 30% in Each of 10 Major Equity Sectors

Click here for larger image.

Source: TheStreet.com Ratings

Among the fund families, the Janus Capital Group leads with five "perfect 10" funds on the adjoining table of sector diversification leaders, followed by investment industry giant Fidelity, with four.