Fidelity's Red-Hot Sector Funds

NEW YORK ( TheStreet) -- The SPDR passive sector funds rank among the most widely used ETFs. Popular choices include Financial Select Sector SPDR ( XLF), with $10.1 billion in assets, and Technology Select Sector SPDR ( XLK), with $8.9 billion. But investors might get better returns by considering the sector funds of SPDR's crosstown Boston competitor, Fidelity Investments. Many of the Fidelity funds -- which are actively managed -- have outpaced the index funds by wide margins.

During the past five years, Fidelity Select Materials ( FSDPX) returned 9.0% annually, compared to 3.2% for Materials Select Sector SPDR ( XLB). Fidelity Select Industrials ( FCYIX) returned 8.3%, compared to 4.9% for Industrial Select Sector SPDR ( XLI).

Other Fidelity funds that surpassed competing SPDR ETFs by more than 2 percentage points include Fidelity Select Health Care ( FSPH), Fidelity Select Technology ( FSPTX), and Fidelity Select Biotechnology ( FBIOX).

The Fidelity funds are not newcomers. Fidelity was a pioneer in the sector business, introducing its first industry funds in the early 1980s. Today the company has 41 sector funds. The group includes such narrow choices as Fidelity Select Insurance ( FSPCX) and Fidelity Select Chemicals ( FSCHX). Financial advisors have long used the sector funds to implement trading strategies. But in recent years, the Fidelity funds have been overshadowed by ETFs.

The ETFs have some clear advantages, including low expense ratios. The SPDR sector funds have expense ratios of around 0.18%, while the Fidelity funds charge about 0.81%. As actively managed portfolios, the Fidelity funds can sometimes miss the target. Fidelity Select Energy ( FSENX) and Fidelity Select Consumer Staples ( FDFAX) have trailed comparable SPDR funds.

But Fidelity's active managers have the freedom to overweight their top picks, an advantage that often results in strong results. A compelling choice is Fidelity Select Technology. During the past five years, the fund returned 9.3% annually, compared to 6.6% for Technology Select Sector SPDR.

The SPDR technology ETF is dominated by a handful of giant stocks, including Apple ( AAPL), International Business Machines ( IBM), and Microsoft ( MSFT). Fidelity's portfolio manager Charlie Chai ranges more widely, buying small stocks and foreign issues as well as familiar blue chips.

Chai holds a mix that includes rapid growers as well as cyclical names that have fallen out of favor. A growth star in the fund has been ( CRM), which delivers software from the cloud that can be used by companies to provide customer service. Chai says that the company can continue growing for a sustained period. "They are taking market share away from established software competitors like Oracle ( ORCL)," he says.

Chai aims to buy cyclicals when they are out of favor. A cyclical holding is Micron Technology ( MU), which makes semiconductors that are used for data storage.

Some holdings are stable performers that can increase sales at annual rates of 10% or so. A stable holding is Visa ( V). As a dominant player in the expanding credit-card business, the company can continue growing steadily.

Despite the strong returns of the Fidelity sector funds, many investors prefer ETFs because they offer some key advantages. While mutual funds like Fidelity's are only priced once a day at the market close, investors can trade ETFs constantly. Many ETFs can be tax efficient.

But the Fidelity funds could soon be offered as ETFs. Fidelity has filed with the SEC to begin providing actively managed ETFs. So far Fidelity has only filed to open a bond fund, but more active ETFs are likely to follow, says Pooneh Baghai, a consultant with McKinsey. She says that Fidelity is likely to roll out a host of active ETFs, including portfolios that are based on the sector funds. When that happens, Fidelity investors will be able benefit from the lower costs of ETFs and from Fidelity's experienced active sector managers.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.