Don't Bank on These Funds

Returns and prices in the financial services sector have been pounded down severely, and although there's plenty of danger among financials, savvy investors are looking for opportunities to profit.

The returns of the three funds outlined below are symptomatic of the abysmal performance in the sector overall. Each has lost 40% or more of its value over the past three years. Although contrarian investors may be tempted to use these unloved funds as a potential way to profit from a turnaround, some of them have risks that go beyond their exposure to financials.

Fund specifics
Rydex Banking Fund Investor Class (RYKIX) is a team-managed fund that invests in companies in the much-maligned banking sector. The fund invests in a variety of commercial banks, thrifts, and beleaguered mortgage finance stocks. JPMorgan Chase (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , and HSBC (NYSE: HBC  ) are top holdings in the portfolio of slightly more than 70 stocks.

ProFunds Banks UltraSector Fund (BKPSX) provides leveraged exposure to the Dow Jones U.S. Banks Index. This index includes all regional and major U.S. domiciled international banks, savings and loans, savings banks, and thrifts. Although there are roughly 280 stocks in the index, the fund owns about 80 stocks. Three of these, JPMorgan Chase, Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) account for over a third of the fund's assets.

Fidelity Select Home Finance (FSVLX) invests in companies providing mortgages and other consumer loans and related services associated with home finance. The fund has its heaviest exposure to mortgage giants Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) , which has driven down returns sharply in the past year. Fidelity has the smallest number of holdings of the three funds -- just under 60 securities -- and it also has the lowest fees and investment minimums. But the ease of access should not blind investors to the volatility of this fund.

Fund facts

Fund

3-Year Annualized Return

Net Expense Ratio

Total Assets as of 6/30/2008

RYKIX

(16.6%)

1.37%

$11 million

BKPSX

(23%)

2.57%

$8 million

FSVLX

(24%)

0.92%

$110 million

Source: Morningstar.

Fund prospects and risks
The financial services sector has been in a downward spiral, and the ever-worsening credit crisis has helped to make this sector one of the worst performers. Market sentiment has been decidedly negative for stocks in this sector, and an investor should expect volatile markets and wide fluctuations in price.

Although storm clouds over financials have far from disappeared, it's possible that most of the bad news might be incorporated in share prices, limiting any further downside for these funds. With the sector so beaten down, there is the potential for overreaction on the upside to positive news, which could be a boon to holders in this sector -- and especially for ProFunds owners, because of the fund's 150% leveraged positions.

Unfortunately for fund investors, that rebound may come too late. Of these three funds, Fidelity Select still has enough assets to give it a good chance of surviving. The other two funds, on the other hand, have shrunk to the point where it's uncertain how long they'll be able to continue operating.

Portfolio fit?
Contrarian investing does not always pay off; sometimes, the market takes its own sweet time recovering from a downturn. Investors unable to withstand the extreme volatility of the financial sector may want to look elsewhere for investment opportunities. For those able to put up with short-term fluctuations or extended periods of negative returns, financials may pay significant rewards over the long run -- but don't bank on it happening tomorrow.

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Fool contributor Zoe Van Schyndel now lives in the Seattle area, where she enjoys the coffee and natural wonders. She does not own any of the funds or securities mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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