Money: Sector funds in fashion

By Philip Macalister

Investing is a bit like fashion. They both have trends that are in one season then out the next.

Fashion has its beauties, like the bellbottom trousers and platform shoes of the 1970s, and with investing people often switch between a value or a growth approach.

One of the latest trends to re-emerge in the funds management world is sector, or theme, funds.

The concept behind sector funds is simple. Instead of having an investment universe that is broad and geographically defined, such as international shares, you have a universe that is global but focused on one industry, such as energy or resources.

The idea is not new, but this time around there has been an improvement in the garment and some of its flaws have been fixed.

In the United States sector funds are definitely in the ascendancy, and there are signs that this trend will hit New Zealand sooner rather than later.

It could be argued that the listed property sector has embraced this concept for some time by having companies that are allocated to certain sectors of the market. For instance, if you want exposure to retail shopping malls, you buy St Lukes. If it is prime CBD you are after, buy AMP Office Trust.

A number of unlisted sector-specific funds have been around for some time, including the top-performing New Zealand Funds Management Property and Infrastructure Trust, the not-so-hot New Zealand Rural Property Trust, and cyclical player BT Funds Management's Global Energy and Resources fund.

More recently, Calan Healthcare has launched a highly successful global Healthcare fund, BT has announced it is launching its global TIME technology fund on May 1, and Invesco in Australia is planning to promote its Global Themes Fund in New Zealand from the end of this month.

The chief investment officer of BT Funds Management, Craig Stobo, says the reason for this shift to sector funds is simply the globalisation of the world's economy.

Many companies operate worldwide, so it is hard to pigeonhole them in their country of domicile.

Take Coca-Cola, for example. While it is a US-based company, it derives a significant chunk of its income from all over the world.

This whole theme of globalisation is being swept along by the World Trade Organisation, the unification of Europe and falling trade barriers.

The more traditional approach to investment decision-making required someone to make a call on which countries are most likely to prosper.

Invesco chief investment officer Derek Webb says trying to pick the best countries each year is very hard - "like trying to predict the weather."

"Globalisation of markets and companies means geographic location is becoming secondary to a company's brand, product and growth opportunities."

Compounding this problem is the lack of diversity in many sectors in many countries. If you were in New Zealand and wanted to invest in telecommunications, there has been only one choice.

The idea now is that an investor can say: "I want telecommunications stocks in my portfolio. Which companies offer the best value on a global basis?"

Mobile phone maker Nokia is another example of how the old style was potentially restrictive. Nokia is the biggest cellphone maker in the world and it has earnings growth of 20 per cent a year, making it a good stock to own.

But the company is based in Finland. Under the old rules of investing by geography, you would probably never in your wildest dreams consider investing in Finland. Yet by taking a sector approach and including it as technology, it suddenly becomes available.

This latest take on sector funds is the second in less than 10 years. In the early 1990s a number of fund managers in New Zealand, such as Prudential and Tower, launched sector funds based on geography. However, most of those funds are no longer offered in the market.

The general manager of IPAC Securities, David van Schaardenburg, says the old style of country-specific sector funds did not work as they were just too inflexible and lacked diversity. When a country bombed, so did the fund.

With industry-specific funds, the idea is that researchers would pick the sectors that are likely to perform. Some of the choices, such as technology and healthcare, are relatively easy to pick. However, as the global economy rapidly evolves there are other, less obvious areas, such as logistics and distribution.

With the move to selling products over the internet instead of walking down to the local shop, there has to be some way of delivering the goods.

A cynic could say sector funds are just another way of packaging up a product to make it more saleable, especially in hot sectors such as technology.

Not so long ago a company such as Telecom was considered a telco, rather than a tech stock. Likewise, companies that for years have been making semiconductors are no longer manufacturing companies, but tech stocks.

Mr Stobo says the idea of sector funds fits in with the much talked about shift from the old economy to the new economy. A fund such as BT's TIME (telecommunications, information technology and media enterprises) is investing in companies that are changing the world.

The natural diversification and lack of dependence upon country selection for performance is a strength of this approach.

While the logic of a sector approach to investing is there, investors need to be careful before rushing into sector funds as there are a number of issues to consider.

For example, say you own some other international share funds. It is worth seeing how much exposure they have to various sectors of the market.

This week, London fund manager Michael Watt, of Henderson Investors, was in New Zealand talking about two British-listed investment trusts he manages: the sterling 263 million ($845 million) Henderson TR Pacific Fund and the sterling 74 million Henderson Far East Income Trust, which is mandated to buy high-yielding shares.

Mr Watt says the Pacific Fund, which has done well recently, has a 55 per cent exposure to technology, against a benchmark of 29 per cent.

Also, as there is still only a handful of sector funds available in New Zealand, you need to balance the mix carefully.

For instance, if you divide the global economy into sectors based on the stocks in the MSCI index, just 4 per cent are classified as technology, he says.

Likewise, Mr Stobo says investors need to be careful in their approach.

Whichever approach is taken, it is very hard for a retail investor to make decisions about country and sector allocation.

He illustrates the point of inadequate diversification by citing BT's Pacific Basin Fund in the early 1990s.

Back then the emerging Asia tiger economies were in vogue and money poured into trusts such as Pacific Basin. However, things turned bad in the mid-1990s when the Asian crisis hit.

Investors who stayed in during that period got badly burned (however, last year the fund again did really well).

Mr Stobo's advice on sector funds: "Don't go to the races on these things."

Another issue to consider is diversification. One of the biggest US managers, Vanguard, refuses to go down the sector-fund route as it reckons such funds are just a magnet for hot money.

It says that instead of betting on a small group of stocks, it would rather try to provide investors with the highest possible returns through broad diversification and quality management.

* Philip Macalister is the editor of online money management magazine Good Returns, which provides news and information on managed funds, mortgages, superannuation and financial planning.