S&P To Investors: Hot Sector Funds Cool Off Quickly

June 27, 2003 (PLANSPONSOR.com) - The percentage of new bond funds among all mutual funds issued in 2003 rocketed up to 32% from just 15% in 2000, as fund companies continue to chase the hottest sectors in the market in hopes of catching investor dollars.

Yet, Standard & Poor’s has some words of caution for mutual fund investors in search of the never-ending summer positive sector fund returns:   “the hottest sectors of the market often cool off quickly,” Gary Arne, S&P’s Managing Director of Funds Research, said in a statement.   Arne went on to caution that fund companies are well aware of this trend and that investors have an uncanny tendency to chase returns and hop on the best performing sector bandwagon.

S&P points to three separate occurrences for evidence of this trend:

  • In 1980, when gold prices skyrocketed toward $800 an ounce and the mutual fund industry produced a flurry of new gold funds just in time for the metal’s slide in price. 
  • During the late 1980s, Japanese funds were all the rage.  Since the Japanese market bubble burst in 1989, however, analysts say investors have made more on currency gains than through the stock investments themselves.
  • Wall Street’s infatuation with emerging markets in the mid-1990s, ending abruptly with the emerging markets crash in 1997.

However, the most dramatic example is also the most recent: the torrid love affair investors and mutual fund companies had for “new economy” funds investing in Internet, technology and telecommunications stocks. For a time, funds that invested heavily in the technology sector and other high growth areas flourished. But like many other funds that concentrate in a particular sector, many “new economy” funds launched at the height or near the tail end of the Internet run up proved to be disastrous investments for many as the NASDAQ fell 78% from its March 2000 peak.

A case in point was Internet funds.  Launched just as the market peaked in March 2000, Internet funds raised billions of dollars for many funds companies, only to have many of the funds fold 18 months later.  US technology funds returned an average of 23.65% through the first two months of year 2000.  The same set of funds lost an average of 43.53% from March 1, 2000 through December 31, 2000, according to S&P’s mutual fund database.