In Search Of Stinky Sectors

5/16/2016


Fund investors should look for opportunities in all sectors, not just the ones performing well.

With that in mind, we looked for rebound picks among the worst-performing sector categories this year, according to Morningstar: Health care (-10.9% average return), technology (-4.1%), financial (-2.6%), and consumer discretionary (+1.5%). These four sectors are the largest in the S&P 500 Index, representing roughly 63% of its total market value.

To flush out high-potential picks, we looked for standouts with above-average scores in our ranking system, which grades some 5,600 mutual funds and exchange-traded funds (ETFs), including more than 500 sector funds. We also focused on low-cost funds. The table below lists eight notable picks, including one traditional fund and one ETF for each of the four laggard sectors.

LEADING FUNDS AMONG LAGGARD SECTORS
-------- Total Return --------
Year-
To-Date
(%)
--- Annualized ---
Div.
Yield
(%)
Exp.
Ratio
(%)
% In 10
Largest
Holdings
%
Foreign
------- 5-Year -------
Fund (Price; Ticker)
5-Year
(%)

10-Year
(%)

Standard
Deviation
R-
Squared
Fund
Score
Consumer Discretionary SPDR
($79; XLY) ETF
3.4
16.3
10.4
1.5
0.14
52
1
14
80
100
Fidelity Select Consumer Discret.
($35; FSCPX)
2.5
13.4
8.6
0.5
0.76
62
11
14
81
68
Fidelity Select Insurance
($68; FSPCX)
3.1
12.4
4.5
1.1
0.80
58
9
14
80
83
Guggenheim S&P 500 Fin'l
($43; RYF) ETF
1.1
10.4
NA
2.4
0.40
12
1
16
82
90
Health Care SPDR ($71; XLV) ETF
(1.7)
16.4
10.7
1.5
0.14
55
0
12
58
94
Vanguard Health Care
($202; VGHCX)
(5.9)
16.9
11.5
0.8
0.36
41
20
12
53
100
Technology SPDR ($43; XLK) ETF
0.4
11.8
8.7
1.9
0.14
61
0
13
76
100
USAA Science & Technology
($21; USSCX)
(3.5)
13.8
9.0
0.0
1.18
39
18
15
75
70
Note: Fund scores are percentile ranks, with 100 the best.     NA Not available.     Total returns through May 10.    
ETF Exchange-traded fund.

Because of their narrow focus, sector funds tend to be volatile — all but the two health-care picks have been more volatile than the S&P 500 over the past five years, based on monthly standard deviation. Moreover, most are concentrated in just a few stocks.

The tradeoff: Sector funds can boost returns and enhance the diversification of a portfolio. One measure of diversification, R-squared, gauges the percentage of a fund's movements explained by movements in the S&P 500 Index. On average, the eight funds have a five-year R-squared of 73%, meaning that S&P 500 movements explain only 73% of fund performance.

Sector funds should represent only a small portion of a diversified portfolio. Profiled below are notable picks from technology and consumer discretionary — two sizable sectors for our Buy List.

Consumer Discretionary SPDR ($79; XLY) has a 24% weighting in media companies and 21% in specialty retailers. The fund earns the maximum 100 in our ranking system, reflecting its 0.14% expense ratio. The fund ranks among the top 1% of its peer group for five- and 10-year returns.


USAA Science & Technology ($21; USSCX) ranks among the top 19% of its peer group for three-, five-, and 10-year return. The fund has 165 holdings, with Alphabet ($731; GOOGL) its largest position at 7% of assets. The expense ratio of 1.18% is below the category average of 1.31%.

OUR RECOMMENDED MUTUAL FUNDS
Investors wishing to mimic our recommended Growth and Conservative portfolios should purchase the funds listed below in the proportion suggested by the target weights.
Year-To-Date *
--- % Of Portfolio ---
 
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating †
Baird Core Plus Bond ($12; BCOSX)
4.3
A
9
4
88
Dreyfus MidCap Index ($34; PESPX)
5.5
A
0
0
76
Dreyfus Small Cap Stock Index ($26 DISSX)
3.5
B
0
0
96
Fidelity Overseas ($41; FOSFX)
(0.6)
B
9
9
100
iShares MSCI EAFE Small-Cap ETF ($51; SCZ)
1.6
C
4
6
95
PRIMECAP Odyssey Stock ($23; POSKX)
(0.8)
E
10
10
75
T. Rowe Price QM U.S. Small-Cap
($25; PRDSX)
(1.0)
B
7
7
96
T. Rowe Price Value ($32; TRVLX)
1.2
D
10
11
71
Vanguard 500 Index ($193; VFINX)
2.7
B
7
8
83
Vanguard GNMA ($11; VFIIX)
2.3
C
0
0
92
Vanguard Growth Index ($55; VIGRX)
1.2
A
10
11
87
Vanguard High-Yield Corp. ($6; VWEHX)
4.2
D
5
6
97
Vanguard Inter.-Term Tax Exempt
($14; VWITX)
2.6
B
0
0
94
Vanguard Selected Value ($27; VASVX)
3.3
D
5
8
82
Vanguard Short-Term Invest. Grade
($11; VFSTX)
2.3
A
9
4
99
Vanguard Strategic Small-Cap ($29; VSTCX)
1.3
C
5
6
92
Vanguard Total Bond Mkt. Index
($11; VBMFX)
3.8
B
0
0
76
Vanguard Wellesley Income ($26; VWINX)
5.2
A
0
0
99
Vanguard Wellington ($38; VWELX)
3.7
A
10
10
98

* Year-to-date ranks through May 10 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%;
E = bottom 20%. † Fund ratings are percentile ranks based on our fund-rating system.


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