S&P Picks 2 Top Mutual Funds Using Stovall’s Sector Strategy

Delafield, Royce funds heavily exposed to three sector winners of 2010

A member of Standard & Poor's mutual fund team has picked Delafield Fund (DEFIX) and Royce 100 Service Fund (RYOHX) as two excellent sector-focused funds to invest in based on a recent study by S&P Chief Investment Strategist Sam Stovall.

Mid-cap value fund DEFIX has achieved a 10-year annualized total return of 12.9%, outperforming the peer average return of 7.5%, while small-cap core fund RYOHX has achieved a five-year average return of 8.29% versus peer return of 4.08%, according to S&P Equity Analyst Ari Bensinger, who used S&P’s MarketScope Advisor fund screening tool to identify the two funds.

As a member of the S&P mutual fund research team, Bensinger set out to identify two mutual funds that are heavily exposed to last year’s top sectors.

“We wanted funds that had a good long-term record,” Bensinger (left) said Wednesday. “Based on Sam’s study, we believe there’s a good chance you will outperform in 2011 if you invest in these two funds.”

With the start of 2011, investors must decide whether to stay with last year¹s top-performing sectors or to shift some assets to last year’s sector laggards in hopes that they will post a rebound. Stovall’s sector-based study sheds light on this dilemma by looking at results over a 40-year period.

The study found that an investor who chose to focus on the prior year's three best performing sectors outperformed the S&P 500 benchmark 70% of the

time. On the other hand, an investor who chose to invest in the prior year's three worst performing sectors beat the market only 40% of the time.

“The primary point is that the Delafield and Royce funds are heavily exposed to the three sector winners of last year,” Bensinger said.

The best-performing sectors are Consumer Discretionary, up 26% in 2010 versus 2009, Industrials, up 24.7%, and Materials, up 20.6%. The funds Bensinger identified, both S&P four-star funds, also are well positioned in terms of metrics such as their individual holdings, expense ratio and turnover.

Stovall said that his sector strategy stems from a book he wrote last year, “7 Rules for Wall Street,” which looked at sector-based exchange traded fund portfolios. The rule that Bensinger’s picks demonstrate is “Let your winners ride, but cut your losers short,” a technique that indicates investors are better off buying last year’s winners than buying last year’s losers.

The Consumer Discretionary, Industrial and Materials were the strongest-performing sectors in 2010 in a rebound from their weak performance a year before, Stovall noted. In a bear-market bottom, investors tend to be unreasonable in their panic. Then again, investors are opportunists, so if stocks are being given away at fire-sale prices, they’ll scoop them up.

“It’s consistent with history that as we emerge from a bear market and a recession, those sectors that were priced to go out of business but didn’t tend to do the best in the first year of a new bull market,” Stovall (left) said. “Cyclical sectors do best in the first two years of a bull market. It’s not too surprising to see that investors had been embracing Consumer Discretionary, Industrials and Materials. These were the best performing groups in 2010 because most economists had been projecting a very slow economic recovery. Investors have gravitated toward and stuck with the cyclical sectors, hoping that a global economic recovery will continue to have staying power.”

Read Sam Stovall’s asset allocation thoughts from Sept. 1, 2010 at AdvisorOne.com.

Another S&P wise person, Vaughan Scully (left), writes monthly for Investment Advisor magazine in a column called ETF Advisor; his most recent article is on overseas real estate ETFs. Through his "Fund Researcher" blog on AdvisorOne, Scully explores mutual funds and ETFs. His most recent post is on finding high-yield muni bond funds that perform better than Treasuries.

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