Remember 1997? Investors in the specialty-financials arena do, because that was nearly the last time anything good happened to the sector. In that year, there was a lot of talk about how baby boomers would need more and more financial services, why banks' and brokerages' earnings were less cyclical than they used to be, and how consolidation would propel shares in the sector ever higher. Indeed, the average fund in the category posted a stunning 46 percent gain that year. By contrast, the average tech offering rose just 9 percent.
During the next two years, the tables were turned. Takeover activity in the sector slowed in 1998, and the specter of interest-rate increases hovered over financials last year. Since the beginning of 1998, the average fund in the category has eked out only a single-digit cumulative gain.
There are several arguments in favor of investing in this area. The sector might see an upturn in takeover activity, after Congress enacted legislation last year that tears down some of the walls between banks, brokerages and insurers.
In recent weeks, investors have shown renewed interest in the sector on the strength of solid earnings reports and modest valuations. The average specialty-financials fund owns stocks trading at a 50 percent discount to the S&P; 500, in terms of price to earnings. Yet, those holdings have posted three-year earnings gains virtually identical to the index's.
There are several good funds that allow one to play the sector. Each of these funds is broadly diversified among financial subsectors. The funds all have moderate to appealing costs and experienced managers.
John Hancock Financial Industries. Lead manager Jim Schmidt set up this fund a few years ago to capitalize on an expected wave of mergers among banks, brokerages and insurers. The fund spreads its bets to firms that are considered likely takeover targets. This fund's record is average during the past three years, but given Schmidt's experience, we expect better things over the long haul.
Davis Financial. The Davises have been investing profitably in financials for decades, and Chris Davis, along with co-manager Ken Feinberg, is no exception. They focus on picking up shares of good financial firms on the cheap. They have a five-year return that is better than more than 90 percent of their peers.
Invesco Financial Services. Manager Jeff Morris has put together a healthy mix of banks, brokerages and insurers. Morris focuses on market leaders that are growing their revenues and earnings at a solid pace. This fund offers a three-year return in the top quartile of the group.