John Heffern of Delaware American Services Fund

Quick Take: Investing in service industries yields competitive returns with less volatility than other industries, says John Heffern, lead manager of Delaware Group: American Services/A (DASAX). Heffern follows this strategy by focusing on companies with growth rates of 10% to 25% annually.

Looking for moderately growing companies has led Heffern to financial, consumer, and business services sectors. He particularly likes financial services because companies there tend to be durable and able to benefit from technology.

Though Heffern highlights a growth strategy for the fund, Standard & Poor’s will be reclassifying it as a mid-cap blend portfolio because of its sizable stake in financial services, a predominantly value sector. The fund would retain its 5-Star rank regardless of its classification.

The Delaware fund’s results show it has been able to generate competitive returns with moderate volatility whether classified as growth or blend. The portfolio’s standard deviation (17.78) is lower than the average for mid-cap blend funds (19.08), and the average for mid-cap growth funds (23.62).

For the three years through last year, the fund rose an average annualized 15.4%, versus 4.1% for mid-cap blend funds, and a loss of 7.9% for mid-cap growth funds. Heffern credits his results to his moderate growth strategy and to avoiding “fiascoes.”

The Full Interview:

S&P: What are the benefits of investing in service industries?

HEFFERN: We started the fund because we felt service industries provided low beta, high alpha investments. There’s been a major shift toward services throughout the U.S. economy. We’ve found opportunities in financial, consumer, and business services, but not technology hardware or health care because those sectors have above-average volatility. We’re aiming for an investment vehicle that is more risk adverse, but has competitive returns over the long run.

We look for moderate rates of growth, ranging from 10% to 25% annually. Rather than hyper-growth companies, or slow growth companies, we look for companies in the middle with improving margins and strong management teams. We like companies that are not overly mature.

S&P: Why do you like the financial services sector?

HEFFERN: Financial services companies tend to be durable and able to benefit from technology. The business models of financial services generally hold up, and the companies can grow more slowly than some sectors, but they grow in a sustainable manner. These stocks have also been market leaders for extended periods of time.

S&P: Are you planning to reduce your financial services exposure if interest rates rise in the future, as many expect?

HEFFERN: We anticipate reducing our financial holdings, although we are positioned for rising interest rates. We don’t own large consumer banks, and our bank holdings are likely to benefit from higher rates because their asset management fees are likely to move up with higher interest rates.

S&P: Do you think the ongoing mutual-fund scandals will have a significant impact on the financial services industry?