"Select" Opportunities

05/28/2004 12:00 am EST

Focus:

"Many investors may have little or no experience with sector funds, but we recommend these funds to enhance a portfolio’s offense and, as importantly, defense," says mutual fund expert Jim Lowell, who discusses his latest favorites from among the 41 Fidelity Selects.

"I think that every investor can benefit from investing in sector funds–whether that investor is aggressive or risk averse. The key is to know how to do so. Select funds no longer have sales loads (they were 3%). How about fund expenses? Selects used to be disadvantaged by much higher expenses and trading costs than diversified growth funds, but no longer. And, Selects have significantly outperformed the market over the past five years. Within each of the seven major sector groupings, the average return for the Select funds in the group has exceeded that of the comparable Goldman Sachs industry index. Good management, or individual stock picking, have been more than good enough to offset their quite reasonable fund expenses.

"What sectors do I like now? Currently I also have one clear cut theme: avoiding excessive interest-rate sensitivity. Historical interest-rate sensitivity is not the sole or generally even the predominant determinant of my buy, sell, or hold ratings. But it is often a significant factor, and lately a substantial negative factor, as I see rates climbing modestly over the next year. All else being equal, no Select actually tends to go up when the bond market is going down (i.e., when interest rates are climbing). However, it’s to be expected that some sectors must be better than others, beating the overall market, and particularly beating other sectors which are interest-rate-sensitive. Here are our buy recommendations among the Fidelity Select funds:

Consumer

"My favorite areas here are the consumer discretionary stocks found in Leisure (FDLSX), which invests in media, lodging, gambling, travel services, retailers, restaurants, and products like sporting goods, toys, and consumer electronics, along with the media sub-set found in Multimedia (FBMPX), with that fund leaning toward the more aggressive end of media: cable systems and newer-tech firms like Yahoo. Food & Agriculture (FDFAX) generally benefits from commodity inflation; I don’t expect its unusual positive correlation to the bond market for the past few years to continue into the next bond bear market and I rate the fund a buy.

Cyclicals

"Fidelity Select offers a surprisingly complete selection of cyclical funds, but I generally can’t see the point of going to the same level of detail as Fidelity has in this group, and more often prefer the broader Cyclical Industries Select Fund (FCYIX). I also keep in mind that Industrial Materials (FSDPX) invests in the chemical and paper & forest sub-sectors to the point the manager sees fit, as well as metals stocks. I also rate Industrial Equipment (FSCGX) as a buy. While Air Transportation (FSAIX) is a notoriously unprofitable business long-term (in fact, when you add it all up it hasn’t made a dime since 1920), there are short-term updrafts that one can benefit from. Despite oil price sensitivity, I think the return of business spending will also entail the return of business traveling.

Financial Services

"Although these funds are among the most interest-rate sensitive, it’s difficult, and generally unwise, to avoid financials completely, both because of the sector’s size (recently 21% of the market) and its high dividend yield (part of the reason for the correlation with the bond market; other reasons being direct exposure to bonds, and dependence on refinancings). I rate Financial Services (FIDSX) as a buy. Meanwhile, I prefer Insurance (FSPCX) and Brokerage (FSLBX) to the other home finance and banking areas, mostly because I see more growth in securitized and equity investments than in mortgages and loans.

Health Care

"While the medical delivery sector is a tough, low-margin industry (running hospital and similar chains, and HMOs) with rising costs, the other 4 health care related Selects– Biotechnology (FBIOX), Health Care (FSPHX), Medical Equipment(FSMEX), Pharmaceuticals (FPHAX)–are all Buy-rated growth-oriented producers of health care products. Their only potential downside comes from seed-corn eating politicians overlooking the fact that only newly discovered drugs and products are expensive (due to the patent system, for which we can thank the founding fathers).

Natural Resources

"My favorite here is now Energy Services (FSESX), and it is the only buy rated fund in this sector. The broader Energy sector fund invests mainly in major oils whose stock price is built on the slippery slope of oil and gas prices, looks well-tapped. Energy Services, however, is comprised of drillers and firms that support drilling, who simply won’t be able to resist increasing their activity precisely because of the high crude prices. These are high-stakes gamblers and volatile stocks. I am downgrading the gold sector because its earlier climb was based on the dollar’s weakness, and with the dollar bottoming out, I see more downside.

Technology

"While tech funds are full of sizzle, you don’t have to put more than one steak on the grill. Electronics (FSELX) is the choice for investors looking to invest in the chip makers. I also have buy ratings on Business Services (FBSOX) and Wireless (FWRLX). I’d also note that while I currently don’t dislike any of the technology sector funds, rarely do I see the point in getting more narrowly positioned than the flagship Technology (FSPTX).

Utilities

"Utilities are generally interest-rate sensitive, and the part that’s less so–telecommunications–still suffers from the sector's still-overbuilt nature and heavy competition. For now, our only buy rating sector fund in this area is Natural Gas (FSNGX), as an energy fund holding drillers and gas fields, as well as pipeline utilities."

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