Losing Chase: Slew of New Funds May Augur Bad Times for Health Care, Value Sectors - TheStreet

Fund companies worship at the church of what's working now, offering up new funds to the gods of performance.

The problem is, given how fast the market sets up idols just to knock them down, firms often get the funds out just as the trend is ending. If that's the case now, it may be time to start worrying about what's ahead for value and health care offerings.

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Last year fund shops large and small

rolled out tech- and tech-stuffed growth funds fast and furious on the heels of that mercurial sector's outsize gains and inflows in 1999, but most of those funds' returns and cash flows have since cratered.

Now tech-light value funds, Wall Street's bargain hunters, are in vogue. In fact, on Tuesday another three rolled off the assembly line from

American Express

and an

AIM

growth fund morphed a bit closer to value investing. At the same time, a peek at the health care fund category shows that a startling 30% of the health sector funds out there have launched in the past year after the now-sick category's 55% average gain and record inflows in 2000.

"Over the years we've consistently seen that when an area performs well, you see a lot of new funds there," says Scott Cooley, a senior analyst with fund-tracker

Morningstar

. "Fund companies can chase performance pretty badly, and they're often late to the party. There aren't a lot of new things in this business, and this proves it."

On Tuesday American Express announced the launch of the

AXP Partners Value

,

Partners Fundamental Value

and

Partners Small Cap Value

funds. Unlike most new value funds, such as the much-hyped

Janus Global Value fund set to launch at the end of the month, this AXP trio will be run by veteran value managers who've put up solid numbers running value funds at

Lord Abbett

,

Davis Selected Advisors

,

Third Avenue Funds

and

Royce Funds

. On the same day, AIM Funds announced that its

(AGWFX)

Select Growth fund, which had sampled ideas from the Houston firm's growth funds, will start culling from its value funds and change its name to

Select Equity

on July 13.

Given that a gush of new funds in a given style are typically spurred by superior returns and steep inflows, the bumper crop of some

30 new value funds this year -- compared with fewer than 10 new growth funds according to Morningstar -- is hardly a surprise.

The average small-, mid- and large-cap value funds are all in the black over the past year, easily outpacing the

S&P 500, down more than 16% over the past 12 months.

And thanks to those eye-catching returns relative to growth funds' steep losses, money is flowing into value funds again after net outflows in the past couple of years. Through the first half of this year, investments into value funds outpaced redemptions by some $36 billion, compared with $1 billion for growth funds, according to the latest data from New York fund consultancy

Strategic Insight

.

In light of those cash flows, the bevy of new value funds is hardly surprising. After all, when big-cap growth funds took in a record $119.6 billion last year, fund companies rolled out 47 rookies, despite the categories already swollen ranks. For comparison, between 1998 and 2000, fund shops launched 126 big-cap growth funds, compared with 63 big-cap value funds.

In sum, more than a quarter of large-cap growth funds launched in the past three calendar years. The numbers are even starker when it comes to sector funds where fund companies, like fund investors, can get surprisingly aggressive when one sector rockets up. Though we've made much of the stunning glut of new tech funds that launched last year, the health care category also illustrates how a glut of new funds focused on a hot sector often shows up just in time for the party's end.

"Many fund groups wait until a style or sector is hot before they launch products," says Dave Haywood, an analyst with Boston fund consultancy

Financial Research

(FRC). "I'm sure if you look at market tops and product development, you'll see that once many funds show up, you're near a top."

Last year, we crunched the numbers and found that in the 1990s no sector-fund category beat the S&P 500 in the year after fund shops launched the highest number of new funds. That doesn't bode well for health care funds this year.

The health care sector was a port in a storm for tech-sick investors last year. The average health fund rang up a 55.4% gain, compared with a 9.1% loss for the S&P 500.

As you might imagine, those gains drew a serious cash geyser from investors and a similar

gush of new health care funds from fund companies. Investors stuffed more than $14 billion into health funds last year, nearly triple the category's previous one-year record inflow. No doubt tantalized by those greenbacks, fund companies launched 13 new health funds last year and have rolled out 16 over the past 12 months -- adding up to more than 30% of the entire category.

In order to stand out from the crowd, many of these new funds focused on the biotechnology sliver of the health sector, like this year's freshly minted

John Hancock Biotechnology

and

Turner Healthcare & Biotech

funds. This level of specification often leaves a fund manager and investors painted into a corner when the sliver falls from favor.

"Most people can live long and healthy lives without owning a biotech fund," says Cooley. "When fund companies start offering new funds in narrow areas, that's reason for concern. That's what happened in 1993 and 1994 when emerging markets surged and imploded. And when the tech sector started getting carved up more and more finely, many of those funds crashed and burned spectacularly. If you've got a good health care manager, why tie his or her hands to one part of the sector?"

Unfortunately, many of these new funds showed up just in time for the sector's momentum to cool. The average health care fund is down nearly 12% this year. Redemptions from health funds have outpaced investments by some $870 million so far this year through April 30, according to FRC.

The bottom line is that investors and fund companies that jump on a hot sector or style's bandwagon are both making a probably ill-timed bet in the short term. Both might do better to assemble a broad menu of solid funds for the long term. If that's your goal, but the mountain of funds seems daunting, check out our

guide to building a diversified portfolio -- including links to fund screens where we've singled out candidates with a knack for topping their peers through at least a few market cycles.

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

imcdonald@thestreet.com, but he cannot give specific financial advice.