If I asked you what funds would've made you the most money over the last five years, you probably wouldn't guess financial sector-funds, would you?
No, they're not sexy. They invest in the stocks of banks, brokerages, insurers, fund companies or some blend of all four. But the steady demand for those shops' services, a bull market and a spotty stream of mergers has made their performance tough to ignore. Financial funds' average 17.9% gain over the last five years and 42.8% gain over the last 12 months top all other fund flavors, according to
For a little insight into the sector's prospects going forward, we turned to Jim Schmidt, who manages a range of open- and closed-end financial funds for Boston shop
John Hancock Funds,
and has been focusing on stocks in this sector for more than 15 years. Jim's
Financial Industriesfund, which I've owned since its inception, trails its average peer over the last year, but it's still up more than 33%.
Unlike some sector-fund managers, he doesn't tell reporters he loves every company on his radar screen. Want to know where he sees opportunities and traps down the road? Read on.
Fund: John Hancock Financial Industries
Assets: $2.7 billion
1-Year Return/Ranking: 33.2%/Trails 72% of peers
3-Year Annualizer Return/Ranking: 4.3%/Beats 57% of peers
Sales Charge/Annual Expenses: 5%/1.35%*
*Using Class A shares as an example.
1. To start off with, obviously last year was a great year for financials. You folks have done even better than the average peer, but just so far this year it's been kind of a rocky period for the fund, and a bit harder than its peers. Is there something about this year that you didn't anticipate or some kind of tectonic shift you didn't see coming?
I think two things hurt this year. Most of all, it's been the poor performance of the
and its implications for the brokerage stocks. So the brokerage group which helped us for most of last year has hurt us slightly.
( SCH) has been a big loser, but also
( MER) and
-- all those stocks went soft. And then, the banking area, I guess some of the best performers year to date have been a few of the banks that ran into problems last year like
. They sort of bounced back, year to date.
Our call has been against stocks like that; we have more the revenue growth banks like
Bank of New York
( MEL) for the last year that have been better performers, but year to date things have reversed. And I'd say the stocks we have in the bank area have done well over the last year but since Dec. 31, they've underperformed the problem banks. So I think those are the two key things that separate us from other people so far.
2. What financial industries look most attractive to you right now, and what are one or two companies that stand out to you as being solid?
The groups we favor right now are, first of all, the property casualty companies, which have suffered for a couple of years. They don't have a lot of credit risk and we think they're susceptible to possibly being involved in acquisitions with European buyers.
And here I would mention maybe my two favorite names,
, which is a financial guarantor and
Marsh and McLennan
, which is a property casualty company even though they own Putnam, which is part of the story, but they are on their way to participating in the pricing increase in property casualty.
The security brokers I mentioned have been poor performers year to date, and that business is lousy right now; there are almost no public offerings taking place and M&A work, M&A advisory work is way down, too. But that we think can change fairly quickly. And later this year we expect that business to look much better.
So we're sticking with the securities firms, and our biggest holdings there would be Merrill Lynch and
Returns You Can Take to The Bank
Source: Morningstar and Baseline/Thomson Financial. Returns through March 9.
3. On the flip side, what might be industries and companies where maybe over the next three years you might want to be underweight or not as exposed?
Well, I think there may be a little pain to be felt in the asset management companies, because, I think, right now, asset revenues have declined quite a bit from what they averaged last year and I'm not sure that's in everyone's thinking. I think most investors think of these companies as sort of steady growth companies, but you're starting the year from an asset base that's quite a bit lower than average of the last year, and so you need a substantial gain in the market, just to sort of break even with last year.
I don't think that's in most people's thinking, so I probably wouldn't invest in the asset management companies right now.
Do you think that maybe part of that is that people kind of fall in love with the demographics argument?
Yes. Which is a fine argument -- there's nothing wrong with that but demographics are a reason maybe to buy life insurance and securities firms too, but within those three groups, I think the asset managers have kind of the mystique of steady growth, 20% growth year over year and that's not going to happen this year.
And then the life insurance stocks, I'm just a little wary of right here because I'm not sure what's going to happen in state tax reform and that might reduce the appeal of some of the life products.
4. Now some folks might be thinking of owning shares of a financial sector fund if interest rates come down. To a lot of folks that's a knee-jerk reaction -- they say OK, this fund is going to go up, the sector is going to have the wind at its back a bit. But so far this year, given the economic slowdown, the withered retail market and the sagging market in general, financial funds are on the wire like just about every other kind of stock fund. What's your expectation for this year given such a murky outlook?
Well, talking about how interest rates affect financials, you kind of have to think about both the earnings impact, and then the impact on the stocks. In fact, lower rates don't make a huge difference in the earnings outlooks for our companies, and I think maybe investors tend to overestimate that.
But, historically, lower rates, as you've observed, help financial stocks. Most of the time, maybe three-quarters of the time, you outperform over the next 12 months once the Fed starts easing. So not all the time, but most of the time. So based on that history, I would tend to think it would tend to be good news and we were pleased to see the Fed cut.
10 Questions Archive
Franklin Global Health Care's Evan McCulloch
Sit Science & Technology's Gene Sit
Amerindo Technology's Alberto Vilar
Now what has hurt, what has overwhelmed the interest rate impact on the stocks, I think, are concerns about the economy and worries that maybe we'll have a drastic slowdown, and huge earnings disappointments and credit losses. If we are in for a severe recession, comparable with '89-'90, then I think it is early to buy the financial stocks, and we won't see them do much, even though the Fed cuts rates.
But that's not what I'm looking for. I think we're in for an economic slowdown but not a recession, or at least not a recession of any magnitude. And you don't have to worry that you're going to get deluged in loan losses, for example, in the bank area.
Are you in the camp of folks who have been sort of seeing what started out as a second half economic recovery and then have now started to push that back to a fourth-uarter recovery?
I haven't quite pushed that far yet. I'd say I'm still looking for a second-half recovery, but I have to admit you need to keep an open mind about it, and maybe they'll take a little longer for the rate cuts to have an impact than we would have hoped, but at the moment, I'm going to stay with a second-half recovery.
Read the Fund Junkie's remaining six questions.
Fund Junkie runs every Monday and Wednesday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.