Educational Programming Video
The Value Line Mutual Fund Survey
Program 18: Financial Planning Part 7
In the last several sessions, we discussed investment profiles. Today we'll continue the discussion, taking a closer look at some of the different funds that might fall under each of several broad fund groups.
In the last several sessions, we have been discussing asset allocation. This process is basically about squeezing the greatest potential return out of a given level of risk. Although this automatically dilutes a portfolio's potential return, the interaction between different types of investments makes it possible to diversify among asset classes in such a way as to lower the potential risk by a greater amount than one lowers the potential return.
As discussed last time, Value Line recommends we look for mutual funds that fall into seven broad equity categories: Large-Cap Growth, Large-Cap Value, Small-Cap Growth, Small-Cap Value, Foreign Stock, Emerging Market, and Gold & Resources. Although these are good for a general outline, this breakdown does not touch on all of the different types of funds that an investor might encounter.
Let's review the major market sectors in which a fund may invest.
On every Value Line page, we show the percentage of equity holdings that fall into each of ten major market sectors: Consumer Durables, Energy, Finance, Industrial Cyclical, Non-Durable, Retail Trade, Health, Services, Technology, and Utilities.
This breakdown is important because, as one might expect, each has a different performance profile. For example, a fund that has a lot of technology exposure is likely to be more volatile than a fund with a lot of Energy or Utilities exposure. Both funds, however, could fall under the Large-Cap Growth grouping.
Let's take a look at the sectors.
Companies that fall into the Consumer Durables sector make things that you use every day and that last a long time. An example of such a product is a washing machine. Very often, Consumer Durables companies are slower growing, mature firms.
The Energy sector is made up of a number of different types of companies, ranging from integrated oil giants, to smaller natural gas producers. This group tends to move in line with the price of the commodity in which the company operates, meaning that as oil prices rise so do the prices of oil companies.
Finance is also a broad sector. It encompasses everything from insurance, to brokerages, to banks, to Real Estate Investment Trusts. In general, the sector is very dependent on interest rates. When rates go up, the Finance sector tends to move lower, and vise versa.
The Industrial Cyclical sector tends to do just what its name suggests, it cycles from good to bad. These companies generally provide the machines that create the products that you eventually buy. When companies are increasing their production capacity (usually in good economic times) these companies do well. When there is over capacity, however, there is little demand for the products offered by industrial cyclical companies.
Non-Durable products are those that are only useful for a short period of time, such as food or sneakers. Unlike a consumer durable product, which may last 10 to 20 years, your sneakers will likely wear out in just a year or two. Thus, these types of products are continually in demand. Because of this, Non-Durable issues tend to do well in many different market conditions.
The Retail Trade sector is filled with, as you might guess, stores. A shoe store, a grocery store, or department stores are all examples of what makes up this group. These types of companies tend to do well when the economy is strong because that is when people are in a buying mood. When consumers start to pull back their spending, this group performs poorly. The only exception to this is the grocery store group that tends to have steady growth pattern regardless of what is going on in the economy. You always need to eat, but you don't always need to buy a new computer.
The Health sector has historically been a very strong area. Like groceries, consumers that need medical attention tend to get medical attention regardless of the economic outlook. Drug companies and medical facilities are the types of firms you will find here. Medical advances and an aging population suggest that this sector will continue to be strong in the future.
Services covers a broad spectrum of companies. This group includes companies such as lawn-care firms or temporary staffing concerns. Once again, this sector often does well when the economy is strong and people are willing to spend extra money on things they could do themselves.
Technology is by far the most talked about sector. It also tends to be the most volatile sector. In this grouping you will find computer software and hardware firms, as well as those that create the "backbone" of the Internet. Technology firms tend to do well when the economy is strong.
Utilities are just what you thinkutilities. Power companies and telephone companies make up the bulk of this group, but it also contains less well-known groups such as water companies. The group has historically been a slow and steady grower with hefty dividend payouts. Although this is changing somewhat, it is, for the most part, still true.
Now that you know about the stock groups and some of the sectors in which equity funds can invest, we'll look at bonds and cash next session.