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Posting a 2.8% gain, financial services funds stand out in otherwise dreary year


As years go, this one has ranged from dull to dreadful for a good number of mutual fund investors.

Nearly all fund categories suffered losses from January to June as stock prices tumbled, interest rates shot up and the dollar weakened. Only the financial services group stood out, bolstered by the strength of bank funds.

That group, up 2.8 percent, and the natural resources group, which barely broke even, up 0.1 percent, were the only two to show gains. Among the biggest losers were aggressive growth funds, down 9.7 percent, and small-company funds, off 8.1 percent, which were hurt by tumbling technology stock prices.

Health care funds fell 9.4 percent, and utility funds, rocked by the rise in interest rates, fell 9.1 percent. Gold, down 11.1 percent, is fast losing its reputation as a hedge.

Moving overseas helped, but not much. European stock funds lost 1.4 percent; Pacific funds, 4.5 percent, and foreign stock funds, 2 percent.

Over all, the average United States diversified equity fund lost 4.7 percent in the first six months, according to Morningstar Inc.

The financial services funds -- which invest mostly in banks, savings and loans, brokerages, money managers and insurance companies -- had their losers, too, the biggest being Fidelity Select Brokerage and Investment Management.

It fell 9.2 percent, as most brokerage stocks were double jinxed by rising interest rates, which slashed their underwriting fees for new bond issues and brought losses on bonds held in inventory.

But the gains among bank funds, including a 12.6 percent increase for the top performer, Fidelity Select Home Finance, pushed up the group's overall performance.

Bank stocks have mostly been on a strong run since their 1990 collapse, and this year was no exception. Many banks announced double-digit first-quarter earnings in April, and, for the rest of the year, said Sam A. Marchese, who manages the $442 million SIFE Trust, "we see prices of bank stocks rising substantially because earnings should rise 15 to 20 percent over last year."

Given lower bank costs and higher revenues, relatively inexpensive share prices plus accelerating merger activity, managers of the group's best-performing funds this year remain enthusiastic about the sector.

James K. Schmidt, who runs the $540 million John Hancock Freedom Regional Bank Fund, points out that bank earnings have remained strong despite the Fed's interest rate increases.

While the federal funds rate, the overnight interest charged on loans between banks, is up more that 1.25 percentage points this year, the rates banks are paying customers on passbook and checking accounts and certificates of deposit are up only modestly. So banks earn more on the loans they write but don't pay more interest on their accounts.

The strengthening economy also helps. After bank stocks plummeted because of their nonperforming loans in 1990, credit quality began steadily improving. Banks reported declining levels of nonperforming assets for eight consecutive quarters and should post another drop this quarter, Mr. Schmidt said.

Among his favorite banks are Mercantile Bancorp in St. Louis, Whitney Holding in New Orleans and Meridian Bancorp in Reading, Pa.

David H. Ellison manages the $300 million Fidelity Select Home Finance (formerly Fidelity Select Savings and Loan), which owns companies that trade, sell or invest in mortgages. That industry, he said, has been helped, not hurt, by the interest-rate increases.

"The knee-jerk reaction is, when rates rise, to sell financial stocks," he said, but so far the slowly rising rates have helped mortgage dealers by "significantly curtailing refinancings." Also, new mortgages carry higher rates.

The sector would suffer if rates were to rise swiftly and markedly, but even so, Mr. Ellison said, "companies are so much better than they were five years ago because we spent billions of dollars of taxpayers' money to clean them up."

In his view, merger and acquisition activity is out of hand, with valuations moving too high. But even excluding takeover targets, Mr. Ellison is very enthusiastic.

He likes the Greenpoint Savings Bank in New York, First Federal of Michigan and First Federal of Santa Monica, Calif.

Stephen E. Binder is manager of the $175 million Fidelity Select ++ Regional Banks fund and its $110 million Financial Services fund.

Half of Financial Services, which was up 3.8 percent since the start of the year, is devoted to banks, with another chunk invested in consumer finance companies.

Among the brokerages, Mr. Binder likes are Dean Witter, Paine Webber and Lehman Bros.

The SIFE Trust, which owns banks, was set up as a living trust under California law and is available only to residents of California, Nevada and Hawaii.

Mr. Marchese's investing philosophy for the fund is simple: "You buy value and you hang on." Among positive factors he cites for banks are rising dividends.

"We expect more than 100 banks to increase their dividends, and between 20 and 30 that have no dividends will initiate one this year," he said.

He likes three New York banks, Chemical, Citicorp and Chase Manhattan, which he calls "cheap, with improving fundamentals."

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