A fund sector that you can bank on

There's money to be made at the bank, the savings and loan, the real estate investment trust - even selected brokerage houses.

The financial-services sector was one of the better-performing mutual-fund arenas in the second quarter, up 8.2 percent, according to information firm Lipper Inc. That compares to an average 5.6 percent for funds linked to the Standard & Poor's 500 Index.

"Financial stocks are looking good, especially smaller banks and savings and loans," says Brian Piskorowski, a vice president with investment house Prudential Securities Inc., in New York.

Brokerage houses have not fared as well this year, given the stock market's low trading volume, as well as reduced corporate-merge and -acquisition activity. Brokerages do make money during downturns on sell executions, but usually not enough to offset the lack of punch from frequent purchases.

Experts cite three primary factors for the momentum of financial-services funds:

* Low interest rates, thanks to the Federal Reserve. Low rates mean lower costs for financial firms - such as smaller interest payouts to depositors.

* Mergers and consolidations. A recent example of the trend: the acquisition of Dime Bancorp by Washington Mutual, the nation's largest savings and loan. Each new merger entices investors to buy into smaller banks that are likely to be absorbed.

* An expected upturn in the economy and financial markets. Typically, financial issues are among the first to rise in value during a market upturn. But the upturn appears to come in waves: first thrifts, then banks, then more broadly diversified firms, such as credit-card issuers and brokerage houses.

Much of the uptick has already occurred among the S&Ls and smaller banks, experts note. S&Ls, for example, have profited from strong homebuying and refinancing activity. At investment firm Goldman Sachs & Co., for example, investment strategist Abby Joseph Cohen has maintained an enlarged position in financial-service firms in the company's model portfolio relative to the S&P 500 since March of last year.

Today, it's still loaded with financial-sector stocks, but less so than in recent months. Ms. Cohen and her staff are now looking for financial firms with lower price-to-earnings ratios than the highest-quality stocks in the sector. In short, they are buying selectively.

In choosing a financial-services fund, experts say it is important to carefully examine the portfolio of the fund. Returns can vary sharply. Case-in-point: Of the 89 financial-service funds tracked by Morningstar Inc. through July 2, the average return was a so-so 1.4 percent gain this year. But that masks the hefty returns registered by specific funds. For example, the broadly-based Burnham Financial Services Fund was up a whopping 25 percent (see chart below).

"Unless a person is a very vigilant investor, they may not really need a financial-sector fund," says Gabriel Presler, a Morningstar analyst. "If a person is a more typical investor, who doesn't follow their funds daily or weekly, it probably makes more sense to buy into a solid large-cap blend fund, or large-cap value fund. The typical large-cap blend fund has about a 17 percent stake in financial companies; the typical large-cap value fund has about a 25 percent exposure."

(c) Copyright 2001. The Christian Science Monitor