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Investors who exclusively use broadly diversified, no load mutual funds for their stock investments often lose out on opportunities to increase the reward potential of their portfolios.
This article looks at two methods investors may use to enhance the performance of their portfolio of
diversified, no load mutual funds.
- Diversify, diversify, diversify!
- Rebalance your portfolio periodically.
These have become the mantra in the post dot-com era. Stocks, bonds, and cash typically form the major asset classes for constructing portfolios of no load mutual funds.
A lot of emphasis rightly gets placed on the percentage of assets allocated to no load mutual funds of different asset classes. However, the division of assets within a particular class does not nearly get the attention it should.
All too often, investors exclusively use broadly diversified, no load mutual funds for their stock investments. Fidelity Magellan Fund (Nasdaq: FMAGX) and Fidelity Contrafund Fund (Nasdaq: FCNTX) are examples of popular Fidelity funds investors commonly use.
By following this approach, investors often miss out on opportunities to enhance the reward potential of their portfolios.
In this article, we look at how investors can use sector funds to enhance the performance of their portfolio of diversified, no load mutual funds. Although Fidelity funds are presented as examples, the concepts outlined here can be implemented using sector funds managed by other institutions such as Vanguard or T. Rowe Price.
Sector funds confine their investments to a particular sector of the economy. Fidelity funds managed under the Select Portfolios® are sector funds. For example, Fidelity Select Energy (Nasdaq: FSENX) is a no load mutual fund that focuses its investments on various segments of the energy industry such as integrated oil companies, oil and gas exploration and production companies, and oil field service companies.
So how does one use sector funds to increase the performance potential of a portfolio of diversified, no load mutual funds?
Focus on sectors with growth opportunities. An investor having a portfolio of diversified, no load mutual funds may commit a portion of her assets to sector funds that focus on areas having significant growth opportunities, e.g., electronics or software.
Some financial professionals call this the ‘core and satellite’ portfolio approach where the diversified, no load mutual fund is the core and the sector fund is the satellite holding.
Investments in Fidelity funds like Fidelity Select Electronics (Nasdaq: FSELX) or Fidelity Select Software and Computer Services (Nasdaq: FSCSX) can enable the investor add emphasis on growth sectors such as electronics and software, respectively.
Take a proactive approach to sector investing through sector rotation. Like in the previous case, an investor having a portfolio of diversified, no load mutual funds commits a portion of her assets to sector funds.
With this approach, the investor however seeks to maximize the potential of the portion of assets committed to sector funds by periodically switching assets into sectors with higher expected returns.
For example, until not too long ago, major corporations pruned technology related capital spending whereas falling interest rates kept consumer spending strong.
To profit from such secular trends, an investor may choose to invest in Fidelity funds such as Select Consumer Industries (Nasdaq: FSCPX) and Select Leisure (Nasdaq: FDLSX) while avoiding Select Technology (Nasdaq: FSPTX).
AlphaProfit.com's research indicates that sector rotation has the potential to outperform the market averages on the basis of relative returns as well as risk-adjusted returns.
To employ this approach effectively, you need to understand and follow the dynamics of the individual sectors. You must also be able to make informed decisions on sectors to select and sectors to avoid.
The Impact on Your Portfolio. Strong performance from a portion of assets committed to sector funds can materially enhance the return of your portfolio of no load mutual funds.
Fidelity funds such as Select Electronics and Select Software and Computer Services sport 10 year average annual returns of close to 18%; this is nearly twice the 10 year average annual return of 9.4% for the Fidelity Magellan Fund. Using tactical, infrequent rotation of assets among sectors, the AlphaProfit's Focus™ model portfolio has increased at an average annual rate of 34.4% since 1993.
So what do these return rates translate to you in dollar terms? Let's look at an
example:
A $100,000 investment in a diversified, no load mutual fund that grows at 10% per year results in $259,374 at
the end of 10 years.
If the same $100,000 is divided such that $85,000 is invested in the same diversified, no load mutual fund growing at 10% per year and the remaining $15,000 is invested in sector funds growing at 30% per year, the assets will total $427,256 at the end of 10 years. That is $167,882 or 65% more than the $259,374 resulting in the former case.
Thus by allocating even a relatively small, say 15%, of the total portfolio of no load mutual funds to sector funds, you can dramatically increase your returns.
Here are a few key points to remember:
- Investors who exclusively use broadly diversified, no load mutual funds for their stock investments often miss out on opportunities to enhance the return of their portfolios.
- Sector funds can serve as a valuable return enhancing booster for an investor owning a portfolio of diversified, no load mutual funds.
- Investors may choose to take a passive long-term approach to investing in sector funds that target high growth sectors of the economy. Alternatively, an investor can take a proactive approach to maximize the potential of sector funds by periodically switching assets into sectors with higher expected returns.
- Investors willing to look beyond broadly diversified, no load mutual funds have a powerful ally in sector funds. Such investors can materially increase portfolio returns by committing a relatively small fraction of their total assets invested in diversified, no load mutual funds to sector funds.
About the author:
Sam Subramanian, PhD, MBA, is Managing Principal of AlphaProfit Investments, LLC. Sam developed the ValuM™ Investment Process for managing investments. He edits the AlphaProfit Sector Investors' Newsletter™. For the 5 year period ending December 31, 2003, AlphaProfit model portfolios increased by up to 288%, a compound annual return rate of 31%. To learn more about AlphaProfit and to subscribe to the FREE newsletter,
visit www.alphaprofit.com.
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