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Real Estate, Financial Services Could Yield Next Year's Fund Winners

This year's lagging sectors are a good place to look for the best funds of 2000.

And the last (might) be first -- in the mutual fund world, anyway.

Conventional wisdom says that if you want to find next year's top performers, look for the best-performing funds in this year's worst sectors.

Here's a look at


sector indices, ranked from worst to first.

It looks like real estate, financial services, health/biotech and utilities funds are the most promising breeding grounds for next year's winners.

Though it may sound like a bromide, there's evidence that the worst-to-first theory can pay off.

Each year, Chicago fund-tracker


picks a few "unloved funds" -- typically fund groups with low investment inflows and weak performance -- and tracks their performance over the next several years. Since 1987, losers in a given year have outperformed the average stock fund over the following three years a whopping 78% of the time.

All three beaten-down fund categories Morningstar picked at the end of last year -- Pacific funds outside Japan (68.4%), Latin America funds (55.2%) and natural resources funds (26.3%) -- are well ahead of the average domestic stock fund's 24.2% return so far this year, according to the latest data from Lipper.

Aside from health care funds, this year's bottom-feeders are experiencing net investment outflows, which means investors are withdrawing more cash than they're putting in. Meanwhile, technology funds have taken in a record $17.8 billion this year, according to Boston fund researcher

Financial Research


Fund investors' tendency to yank money out of sagging funds and to stuff dollars into highflying funds can create a virtuous cycle in which return-chasing investors sink laggards even further and lift leaders' stock prices and fund returns up even higher.

Investing in these sectors is essentially a contrarian bet against other fund investors, whose flight to tech funds may make these overlooked categories attractive.

But simply buying top funds in sagging sectors doesn't guarantee profits. Experts say a continuing growth- and tech-stock bias could sink these categories even further in 2000. Then again, these sectors could post solid returns when the tide turns against growth and technology stocks.

Here's a look at the prospects for this year's most beaten-down sectors and two or three funds in each you might consider.

Real Estate Funds

Real estate prices aren't dropping, but share prices in real estate investment trusts, or REITs, are plummeting. Typically offering modest returns with significant income, REIT funds returned more than 30% in 1997 and have been dropping ever since.

But they could be poised for an upswing. High-profile value investors such as

Warren Buffett are buying REIT shares, and conservative investors also could come calling because REITs offer high income. Some funds worth watching:


Columbia Real Estate Equity. Since this fund's 1994 inception, manager David Jellison has outperformed his peers on the upside, and the fund's above-average 5.42% 12-month dividend yield has helped it stay out front on the downside. It's cheap, too, with no sales charge and an annual expense ratio a shade over 1%, well below the category's 1.57% average, according to Morningstar. Unfortunately, the fund isn't a secret. The fund's assets have grown tenfold since 1995 to $211 million, and that is a concern.

MSDW Real Estate

. This retail version of


MSDW Institutional Real Estate, launched in April, could be a find. Managers Theodore Bigman and Doug Funke's institutional fund has thumped its peers since 1995, while also producing a 5.37% 12-month dividend yield. But costs could be prohibitive. Class A shares carry a 5.25% front-end sales charge. Its annual expense ratio is 1.6%, slightly above the category average.


Vanguard REIT Index. Die-hard indexers and income-oriented investors should consider this $898 million fund. It hasn't outpaced peers, but its minuscule 0.26% expense ratio and bulging 7.7% 12-month yield could make it right for you.

Financial Services Funds

Investors dropped financials the same way they dropped REIT funds -- like a hot potato after boosting them to outsize gains from 1995 to 1997. So far this year, investors have pulled $4.6 billion out of these funds, according to Financial Research. But a solid economy and the recent

paring of the

Glass-Steagall Act

set the stage for consolidation and could revive the sector. Some promising funds in this sector:


Davis Financial. If you want a steady performer that spreads its assets around the sector, this $916 million fund might be for you. Managers Chris Davis and Kenneth Feinberg consistently outperform their peers with a diversified buy-and-hold approach. The fund's annual turnover rate is just 11%. The fund has held its own this year, staying around the average return for the category. While its 1.06% expense is below the category's 1.63% average, Class A shares carry a 4.75% load.


T. Rowe Price Financial Services. Here's another fund that offers balanced exposure to banks, insurers and brokerages. Started in 1996, the $179 million fund has offered better returns with lower risk than its peers. Manager Jeffrey Morris took the reins two years ago as financials entered their blue period, and the fund has stayed ahead of the pack. Its 1.19% annual expense ratio is below average.


Fidelity Select Financial Services. Fidelity offers separate funds that focus on the industry's subsectors



Select Brokerage & Investment,


Select Insurance,


Select Home Finance), but this broader fund offers better diversification. Select funds' managers don't stick around too long, though. Robert Ewing has run this fund for less than two years, but the firm's deep research bench has helped it outperform in good times and bad, including this year. Despite manager turnover, the $499 million fund's 60% portfolio turnover rate is in line with the category average. Expenses are below average, but the fund carries a 3% sales charge.

Health/Biotechnology Funds

The aging of America and the rest of the world should keep demand for health care high. But steep valuations among pharmaceutical stocks and concerns about a new president capping health care fees have kept these stocks down. This year's best health care funds made heavy bets on biotechnology. Despite the sector's doldrums, the $1.9 billion that investors have pumped into health care funds so far this year shows they expect good things. Some funds worth watching:


Vanguard Health Care. Ed Owens, manager of this $11 billion behemoth, is the category's grand poobah. Using a buy-and-hold approach (just an 11% annual turnover rate) and positions in each of the industry's subsectors, Owens has consistently outperformed peers during his 15-year tenure, including this year. The fund had been closed to new investors, but it

reopened Dec. 20. The minimum investment for non-IRA accounts, though, is now a lofty $10,000. The no-load fund's 0.36% expense ratio is one-quarter the category's 1.67% average.


Fidelity Select Health Care. Manager Ramin Arani took the reins only in August, but the depth of Fidelity's research team has led this fund to solid picks across the industry since its 1981 inception. The $2.7 billion fund hasn't bet too heavily on biotech stocks, which held it back this year. But the fund thrashes its peers over every other time period. Its 1.05% expense ratio is below average, but it carries a 3% sales charge.

Utilities Funds

Deregulation is boosting competition and consolidation, fundamentally changing this sleepy sector. The stocks aren't soaring as investors try to sort out which companies will emerge as winners. Most leading utilities funds are relying heavily on telecommunications stocks. Some leaders:


MFS Utilities. Since the $1.2 billion fund's 1992 inception, manager Maura Shaughnessy has spread her investments across the industry's subsectors, beating peers in every year but one, while taking less risk and producing a higher yield. Keep in mind, her 23.9% foreign stake on Sept. 30 shows a taste for foreign shares. Also, the fund's 1.05% expenses are below average, but its Class A shares carry a 4.75% sales charge.


Fidelity Utilities. Here's an example of a cloaked telecommunications fund that might suit more aggressive investors. This $2.7 billion no-load fund has beaten its peers in each of the past 10 years, according to Morningstar. It's ahead of the pack so far this year, too, probably because more than half its top-10 holdings were telecom stocks on Sept. 30. Also, its 0.82% 12-month yield is about half the category average. Manager Peter Saperstone has only been at the helm since October 1998, but its 0.83% annual expense is well below the category average.