The performance of sector mutual funds relative to benchmarks.

ABSTRACT

Implacable proponents of an all-index funds strategy of investing indefatigably and zealously elucidate how investors are consistent losers (mediocre total returns) in the active versus passive investment management competition and debate. This research study uncovers evidence of outperformance by a subset of sector mutual funds over multiple time periods and measured against various benchmarks. Since historical investment performance is not necessarily extrapolative, a blended approach is advocated as an appealing, discretionary option in constructing portfolios.

Keywords: Mutual Funds, Sector Mutual Funds, Passive Investing, Active Investing

1. INTRODUCTION

At the beginning of the twenty-first century there are literally thousands of equity mutual funds and exchange-traded funds available for purchase by economic agents such as individuals and institutions. The quantity of mutual funds exceeds the number of stocks. Within this bewildering array of choices are funds that specialize in large-company stocks and small-company stocks, funds that are dedicated to a growth-stock investment style, a value-oriented framework, or a blended approach, international funds and global funds, and funds that concentrate on specific industries or segments of the economy.

The academic and professional literature of financial economics is replete with commentary and conclusions regarding the relative performance of mutual funds as investment vehicles. In general, these studies affirm the efficient market hypothesis by exposing the intertemporal superiority--on average--of passive investing in comparison with active mutual fund management. Hence they commonly advocate investing in passive index funds (or exchange-traded funds) as the core component or perhaps the exclusive component of an efficient investment portfolio.

An indexing strategy confers the distinct performance advantage of low expenses (a low annual expense ratio is perhaps the best predictor of good future performance), whereas actively managed mutual funds must overcome the incremental handicap of direct and indirect costs, including management fees and trading expenses. Such fees and expenses are significantly greater than those incurred by passive strategies because of research costs expended by innumerable money managers and analysts in their assiduous search for investment opportunities that have the potential to generate above-average earnings and price appreciation. (This consumption of resources dedicated to the search for incorrectly priced securities is regarded as imprudent and futile squandering by the efficient market hypothesis. Proponents of this doctrine assert that markets are not sufficiently inefficient to enable endorsement of an active fund management philosophy. In contrast, index funds endeavor to minimize costs rather than identify undervalued stocks.)

Hence logic and mathematics unite to produce the inescapable (theoretical and empirical) conclusion that the majority of actively managed mutual funds underperform passive index funds in terms of the total return produced. (A mutual fund's total return is the sum of its capital return plus its income return and implicitly assumes that all investment distributions are reinvested by shareholders. Total return data account for management fees paid to a fund company for analyzing and selecting stocks, administrative fees paid to fund lawyers, accountants and board members, as well as insurance premiums paid to protect board members and fund-company executives from lawsuits, and 12b-1 marketing and distribution fees. These performance data do not adjust for sales loads or trading costs and do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares.)

Legendary investor Warren Buffett, writing in the 1996 annual report of Berkshire Hathaway, declared that "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

The appeal of index funds is that their long-term results are likely to be very competitive, despite their inability to dominate the market. Moreover, this competitive outcome is virtually assured since it is not dependent on investment style, market capitalization, sectors or industries, each of which is in cyclical vogue for various time intervals before falling out of favor as market leadership rotates. This tendency of markets to revert to the mean greatly diminishes the probability that individual actively managed mutual funds or steadfast investment management methodologies will consistently generate superior total returns. Past performance is an unreliable and fickle predictor of future returns. Hence the ubiquitous fine print disclaimer alerting investors that how mutual funds performed in the past is not necessarily an indication of future performance. (The inability of economic agents to presciently engage in market-timing decisions and foretell major economic trends and paradigm shifts stimulates the pragmatic investment recommendation that portfolios should be properly diversified both by asset classes and by investment styles.)

In essence, mutual funds collectively are the market. Before expenses, their total return performance is generally equal to the average market return; after expenses, their performance lags the market by roughly the amount of investment expenses. Thus, on average, investors owning actively managed mutual funds are not rewarded commensurately with the risk undertaken--their performance by and large trails the market.

Although there is widespread acceptance that financial markets are generally efficient, markets are not perfectly efficient. This inefficiency coupled with the appealing opportunity to compete against the market motivates and seduces many investment professionals and individual investors to reject an all-index portfolio and embrace and adopt actively managed mutual funds as the instrument of choice for at least a portion of their investable assets.

A decision to allocate financial resources to actively managed mutual funds presupposes that diligent financial reconnaissance will result in the discovery of an elite subset of gifted investment tacticians, nimble traders and savvy analysts who have historically demonstrated an ability to sagaciously exploit market inefficiencies and anomalies. (An integrated strategy utilizes index funds as the core of a portfolio and infuses prudently and painstakingly selected actively managed mutual funds. Index funds and actively managed funds are not mutually exclusive; they can coexist in a portfolio.)

Passive mutual fund investing ensures competitive total returns over time. But index funds cannot outperform the market, they are fully invested even in bear markets, and they purchase stocks in a programmed, no investment-sifting conformity to their benchmark (defined by criteria such as market capitalization, investment style, or market sector). Unlike index funds, actively managed mutual fund management teams devise proprietary financial screening models that winnow and purge the population of investment candidates by striving to differentiate high-quality, undervalued stocks from low-quality, overvalued stocks in an attempt to outpace the market.

Hence a research issue to be investigated is whether empirical evaluation can deduce a catalog of preeminent actively managed sector funds that have rewarded investors with superior returns relative to benchmarks, peer groups, and investment categories over multiple time frames.

2. SECTOR FUNDS

A significant subset of actively managed funds is sector funds. A sector fund is a specialized mutual fund or exchange-traded fund that focuses on stocks in a specific industry or market sector and concentrates its investment holdings in the targeted slice of the economy.

The universe of sector funds comprises more than one thousand mutual funds (counting multiple share classes) and exchange-traded funds. Morningstar, the pre-eminent information repository of comprehensive mutual fund data, delineates eight sector (specialty) fund categories: precious metals, natural resources, technology, utilities, health, financial, real estate, and communications. Each of these categories is described in the Appendix. Some sector funds focus exclusively on a particular or narrow subsector of an industry. Internet funds are an example.

Unlike the majority of equity mutual funds, sector funds do not invest in a cross section of American or global businesses. Hence they are diversified within their area of specialization but are not diversified across wide segments and industries of the economy. This limited degree of diversification, coupled with the fact that stock returns of companies in the same industry tend to be highly correlated, implies that holding sector funds in isolation is a speculative investment strategy. In other words, sector funds operate without the economic guardrail of statistical diversification that tames and deters the risk of a single investment being the catalyst for catastrophic losses that can devastate a portfolio. Accordingly, sector fund investing is best suited to confidently aggressive and audacious investors who accept the increased risk that is associated with ownership of high octane, non-broadly-diversified portfolios.

The rationale underlying investing in sector funds is the observation that exceptional investment performance often occurs with specialized or focused portfolios. In fact, sector funds regularly appear at the top of the list of best-performing funds--but the lack of diverse industry holdings also induces some sector funds to populate the bottom of the relative annual performance scale.

There are three reasons to own sector funds. First, enterprising investors are enticed by the lure of extraordinary investment performance within small niches of the financial marketplace. Rather than allow style-purity or an inflexibly imposed static asset allocation to dictate their financial fate, they value an investment policy directive granting the latitude to be opportunistic and resourceful in searching for investment opportunities. These adventurous investors establish an overweighted position in a specialized segment of the economy, such as technology or health care, anticipating and seeking to capitalize on perceived secular and cyclical opportunities. Second, a subset of investors is attracted to sector funds that can facilitate steadying the performance of a portfolio because of their low correlation with the S&P 500 Index (an unmanaged indicator of stock market performance and widely followed benchmark). For example, real estate investment trusts not only provide this statistical benefit but also have a negative correlation with the Lehman Brothers Aggregate Bond Index. Similarly, precious-metals funds offer a hedge against a calamitous decline in a portfolio since the performance of gold stocks is markedly different from other investments. Lastly, sector funds are favored by contrarian or maverick investors, with a preternatural ability to think independently and the insight to shift assets into distressed and disfavored sectors or industries that may be poised to rebound.

Sector funds can play a role in a diversified portfolio; however, a portfolio exclusively constructed with sector funds would be highly volatile with erratic performance, and high expenses, portfolio turnover and manager turnover.

Most investors are aware that modern portfolio theory resonates with the conviction that active managers of diversified stock portfolios collectively fail to equal or surpass the average total return performance of the broad stock market. An important issue to explore is whether mutual funds that specialize in specific segments of the economy, such as natural resources and communications, possess sufficient specialized knowledge and accumulated industry expertise in relation to individual economic sectors as to accrue a competitive advantage and performance upgrade over a passive indexing strategy.

This issue is addressed by quantifying both the relative frequency with which sector funds earned excess returns in individually considered (disaggregated) periods of time and the number of funds that fulfilled this objective in jointly considered (aggregated) intervals of time.

3. DATA AND METHODOLOGY

The database employed in this research study is Morningstar Principia Mutual Funds Advanced, dated July 2003 (data as of June 30, 2003). Each mutual fund and exchange-traded fund is classified by investment objective and 12-month, 3-year, 5-year, 10-year, and 15-year compound average annual total return data (geometric total returns) are itemized along with allied information such as annual expense ratios and beta coefficients.

This research study examines each of the eight aforementioned sector fund categories over multiple time periods: 12 months (1053 funds), 3 years (818 funds), 5 years (527 funds), 10 years (190 funds), and 15 years (131 funds). (Values in parentheses tally the total number of sector funds in the eight classifications for each respective time period.)

Investment success must be measured relatively, not absolutely, and adjudicated versus appropriate equity market benchmarks. In other words, it must be established by means of comparative appraisal, not merely in reference to isolated total return data.

Indexes and peer groups are the most common points of reference of the investment landscape and stimulate evaluation of the performance of money managers with respect to their opportunity set. Hence in order to assess the relative performance of sector funds, each fund assigned membership in a Morningstar sector (specialty) category will be measured against three yardsticks: the Standard and Poor's 500 Index, an unmanaged index of 500 companies widely recognized as representative of the equity market in general--the benchmark against which most diversified mutual funds are measured; their peer group, that is, the average performance of funds with comparable investment strategies; and a category benchmark. These comparative measurements will be analyzed for multiple time periods, specifically 12 months, 3 years, 5 years, 10 years, and 15 years.

The category benchmarks and their respective sector classifications (in parentheses) are as follows: JSE (Johannesburg Stock Exchange) Gold Index (precious metals); S&P Midcap 400 Index (natural resources); PSE (Pacific Stock Exchange) Technology 100 Index (technology); Dow Jones Utility Index (utilities); Russell Midcap Growth Index (health); S&P Midcap 400 Index (financial); Wilshire REIT Index (real estate); and Russell 1000 Growth Index (communications). For example, technology funds will be evaluated against the Standard and Poor's 500 Index, the average total return of all technology funds, and the PSE Technology 100 Index.

Excepting the omnipresent S&P 500 Index, the indexes were selected based on their close fit to the funds populating each respective sector and the requirement of fifteen years of data. The average total returns of the Morningstar peer groups are impartial barometers of investment performance because they facilitate independent comparisons of sector funds that invest in similar securities and have comparable investment objectives.

4. EMPIRICAL RESULTS

The purpose of this research study is to investigate two empirical issues that are of vital interest to individual and institutional investors.

The first issue is the extent to which various categories of sector mutual funds have compensated shareholders with a performance advantage in comparison to a broad stock market index, peer groups, and category benchmarks.

The conventional wisdom is that plain-vanilla index funds routinely outclass actively managed funds such as sector funds since they are not weighed down by high expense charges and large trading costs. According to Malkiel (2003, p. 17) "More than two-thirds of professional money managers have been outperformed by the unmanaged S&P 500 Index." Hence the mission to deliver market-beating returns is a loser's game--reinforced by advertising that insinuates discovery of strategies that can exploit or outwit the market (but sometimes delivers nightmarish outcomes), animus regarding statistical data, and hubris-since managers with narrow mandates consistently fail to beat their benchmarks.

Modern portfolio theory acolytes are therefore bewildered by the arrogance and heresy of active managers and sector fund investors who discount the empirical evidence of financial research. Hence a research question to be evaluated is the relative performance of sector fund managers with respect to benchmarks and peer groups.

This issue is addressed for each of the eight Morningstar sector categories for each of five time horizons: 12 months, 3 years, 5 years, 10 years, and 15 years. The results of this analysis are indispensable to investment decision-making since economic agents covet information measuring the relative intertemporal total return performance between passive and active investment approaches.

The initial analytical objective is to calculate the collective percentage of funds in the eight sector classifications that generated concurrently superior total returns to the Standard and Poor's 500 Index, their respective category average, and the specific index used as a standard of comparison for each individual category.

The percentages reported in Table 1 are widely dispersed across the various time horizons. It is significant that the probabilities of outperforming the Standard and Poor's 500 Index are smallest for the two longest periods considered, 10 years and 15 years. The probabilities of outpacing the various benchmark indexes fall within a more narrow range and do not overtake a statistical draw. (The conclusion that roughly half the funds outgained or trailed their respective category average total return is neither mathematically nor logically anomalous.) These findings add credibility to the common conviction that active money managers, when grouped and assessed on average, predictably provide lower total returns than computed for market indexes.

It should be underscored that the percentages itemized in Table 1 are moderately overstated as a result of survivorship bias. Some mutual funds fail to survive and cease operating each year due to poor performance or merger. The derivative effect of this altered landscape is that the performance histories of these unsuccessful and poorly managed funds are removed from databases, distorting average total return calculations of actively managed funds.

As a consequence of the omission of these records, aggregate total return data for each sector fund category (such as technology) inflate the average performance of actively managed funds. Only those funds that continue in operation are included in the averages. Hence each of the values in Table 1 is somewhat overstated because of the removal of discontinued funds, exaggerating the success rate of active money managers.

Regarding Section A of Table 2 through Table 9 there is remarkably wide variation in the summary statistics outlining the probabilities of outperformance of the eight sector categories. Compared to the broad market, no precious metals or utilities funds outperformed the Standard and Poor's 500 Index over 10 years or 15 years, whereas 100% of health care funds and 100% of financial funds exceeded this benchmark over 15 years while 100% of real estate funds surpassed this benchmark over 3 years and 5 years. Analogously, utilizing benchmarks appropriate to each sector category, no natural resources funds outgained the Standard and Poor's Midcap 400 Index over 10 years or 15 years, whereas 100% of health care funds exceeded the Russell Midcap Growth Index over 10 years and 15 years.

In contrast to the indexes the category average summary values are less dispersed and tend toward the expected result of 50%. The incidence of statistical outliers--substantially above-average or below average performance by a small number of funds--skews the results sufficiently to preclude an outcome of 50% of funds surpassing their peers.

The results detailed in Table 1 through Table 9 generally support the conventional wisdom of the efficient market hypothesis. Passive indexing and its concomitantly lower expenses confer a performance advantage over an active management approach that must overcome a (sometimes substantial) cost disadvantage and also discover a number of inefficiently priced stocks. Competing against the market is extraordinarily challenging and engenders mostly lackluster results. Yet some portfolio managers produce superior results.

The second issue of exploration in this research study is to extract information from each Morningstar sector classification that reveals the directory of sector funds that has simultaneously outpaced: the average returns of the broad market, as reflected by the Standard and Poor's 500 Index; the average returns of their respective peer groups; and the average returns of their respective category index benchmarks over various time horizons. This catalog is deduced by individual comparisons of a fund with an index or peer group. Survivorship bias is not an issue with respect to index averages--indexes are not liquidated,--but the peer group statistics exclude non-surviving (euthanized) funds, inflating the average total return and elevating the hurdle rate required to demonstrate relative outperformance.

The normal probability distribution and statistical randomness ensure that some portfolio managers will dominate common yardsticks while others will fail to equal their benchmarks. This fact succinctly summarizes the challenge of investing: What is the degree of confidence that measured portfolio management success--outperformance--is likely to be sustained in the future?

The efficient market hypothesis concludes that outperformance occurs by chance and is unpredictable, equivalent to spinning a roulette wheel. There is a mountain of evidence that the average active money manager underperforms the broad market and other benchmarks. Hence the undeniable logic that an indexing strategy delivers a higher probability of a "winning" outcome for most investors. Such investors are attracted to the guarantee of matching the market and accept forfeiture of the possibility of attaining a market-beating reward.

Indexing cannot dominate the market by earning superior total returns. Yet some mutual fund managers do earn excess returns.

Section B of Table 2 through Table 9 serves as a compelling reminder that money management is a humbling profession. All funds in each of the eight sectors are compared against the Standard and Poor's 500 Index, their respective category average, and their respective category benchmark for multiple time intervals. The percentages of outperformance summarized reveal the daunting challenge of competing against equity market benchmarks.

Considering time frames of 12 months, 3 years, and 5 years, between 0% (technology) and 20% of funds (health care) outperformed all three benchmark averages for all three time periods. For example, T. Rowe Price Health Sciences fund generated a greater average total return than that of the Standard and Poor's 500 Index, the health care category average, and the Russell Midcap Growth Index during 12 months, 3 years, and 5 years. (This fund did not have a 10-year investment record.)

The next phase of the analysis also includes 10-year averages. Between 0% (precious metals, natural resources, technology, utilities, and real estate) and 13.3% of funds (health care) earned total returns that outpaced all three benchmarks for all four time periods. For example, the Eaton Vance Worldwide Health A fund's average total return outshined that of the Standard and Poor's 500 Index, the health care category average, and the Russell Midcap Growth Index during 12 months, 3 years, 5 years, and 10 years. (This fund also had a similar 15-year investment record.) This track record of performance is also registered in the percentage of funds that jointly outperformed each benchmark over 12 months, 3 years, and 5 years.

Finally, 15-year data are incorporated. Between 0% (precious metals, natural resources, technology, utilities, and real estate) and 20% of funds (health care) rewarded shareholders with average total returns that topped all three benchmarks for all five time periods. For example, Eaton Vance Worldwide Health D fund's average total return was superior to that of the Standard and Poor's 500 Index, the health care category average, and the Russell Midcap Growth Index during 12 months, 3 years, 5 years, 10 years, and 15 years. (This track record of performance is also registered in the percentage of funds that jointly outperformed each benchmark over 12 months, 3 years, and 5 years, as well as 12 months, 3 years, 5 years, and 10 years.)

Sections C, D, and E in Table 2 through Table 9 document for each sector classification an elite subset of actively managed mutual funds that has defied statistical probabilities and abundantly rewarded its shareholders with laudable performances. Each of these funds earned an average total return that exceeded the Standard and Poor's 500 Index, the average return of its sector category, and the average performance of the relevant benchmark index for periods of time as short as one year and as long as 10 years or 15 years. It is noteworthy that the majority of these stellar funds charge below-average expenses and have beta coefficients less than the Standard and Poor's 500 Index (1.00).

This roster of cream of the crop actively managed sector mutual funds begs a question which likely cannot be answered with incontrovertible finality. To wit, are these exceptional investment performances attributable exclusively to a remarkably unlikely triumph of extraordinary luck over daunting odds, or may they be the residue of design--vivid testament to skillful stock-picking and portfolio construction coupled with perspicuous financial market acumen and the requisite conviction and discipline to execute a rigorous investment philosophy?

Historical performance is a guide, not a guarantee or blueprint for the future. Investors recognize that passive index funds and actively managed mutual funds are not mutually exclusive options. An integrated approach eliminates much of the uncertainty of investment outcomes, attains the benefits of indexing, and grants the potential advantage of earning excess total returns from actively managed sector funds whose enduring appeal inspires a high level of conviction regarding their prospective performance.

6. SUMMARY AND CONCLUSIONS

Active money managers confront a problematical challenge. To outpace the market they must earn a gross rate of return that--after subtracting investment expenses, which have a malign effect on financial-market returns--is greater than the market's total return.

Influential witnesses such as Bernstein, Graham, and Malkiel are persuaded that superior investment performance is highly improbable and not sustainable. Bernstein (2001, p. 174) laconically summarizes this thesis: "Very few money managers beat the market in the long run; those that have done so in the recent past are unlikely to do so in the future." Graham (2003, pp. 9-10), the father of value investing, remarks: "Since anyone--by just buying and holding a representative list--can equal the performance of the market averages, it would seem a comparatively simple matter to 'beat the averages'; but as a matter of fact the proportion of smart people why try this and fail is surprisingly large. Even the majority of the investment funds, with all their experienced personnel, have not performed so well over the years as has the general market." Malkiel (2003, pp. 191, 200) succinctly states: "The very small number of really good performers we find in the investment management business is not at all inconsistent with the laws of chance." Also, "It is clear that if there are exceptional financial managers, they are very rare, and there is no way of telling in advance who they will be."

Sector (specialty) funds are mutual funds that invest in a specific industry. These concentrated funds often manifest extreme performance. The standard deviation of a typical technology fund is frequently much larger than that of the S&P 500 Index, yet it is sector-focused funds that tend to generate the highest rates of return among all mutual funds during specific periods of time.

This research study uncovered a number of actively managed sector funds, operated by seasoned veterans with industry expertise, that have proven their mettle in delivering a performance bonus compared to multiple benchmarks and peer groups, and measured over various time horizons. This is not a directory of funds' du jour that are making a cameo appearance on a mutual fund-ranking scorecard; on the contrary, both the short-term and long-term results of these funds are praiseworthy.

Aggressive investors may be inclined to hypothesize that the investment performance of the aforementioned sector funds stimulates a vote of confidence resulting in an informed decision that the risk of rejecting an all-index fund portfolio is outweighed by the prospect of garnering superior results.

Excellent portfolios can be constructed by owning shares in index funds plus actively managed funds. Such a blended approach fundamentally subscribes to the verdict of financial market theory by accepting indexing as the core component and cornerstone of a portfolio. It also satisfies the seductive instincts and competitive inclinations of that faction of investors whose predilections demand commitment of analytical resources toward the discovery of portfolio managers deemed to have a realistic probability of delivering market-beating returns with a tolerable level of risk.

It is indisputable that the majority of investors obtain inferior investment results relative to indexing strategies. But there is evidence that detection of outstanding investment performance by a scarce minority of money managers, combined with due diligence of these management teams, may improve the likelihood of selecting sector funds that may reasonably be expected to surpass the total returns generated by indexing. Topics of particular consideration in performing due diligence include vigilant monitoring of significant variables such as defections from the management team, rising expense ratios and shareholder fees, and unmanageable marketing-driven asset growth (the consequence of such girth being that managers are often compelled to hew too closely to benchmarks, perhaps diluting their stock-selection skill).

APPENDIX: SECTOR DESCRIPTIONS

Morningstar Principia Mutual Funds Advanced defines the objective of each of the sector (specialty) categories as follows:

Specialty-Communications

Funds that seek capital appreciation by investing primarily in equity securities of companies engaged in the development, manufacture, or sale of communications products or services.

Specialty-Financial

Offerings that pursue capital appreciation by investing primarily in equity securities of financial-services companies, including banks, brokerage firms, and insurance companies.

Specialty-Health

Funds that seek capital appreciation by investing primarily in equity securities of health-care companies, including drug manufacturers, hospitals, and biotechnology firms.

Specialty-Natural Resources

Funds that seek capital appreciation by investing primarily in equity securities of companies involved in the exploration, distribution, or processing of natural resources.

Specialty-Precious Metals

Funds that pursue capital appreciation by investing primarily in equity securities of companies engaged in the mining, distribution, or processing of precious metals.

Specialty-Real Estate

Capital appreciation from real-estate-related equity securities is the primary objective of these funds.

Specialty-Technology

Funds that seek capital appreciation by investing primarily in equity securities of companies engaged in the development, distribution, or servicing of technology-related equipment or processes.

Specialty-Utilities

Offerings that seek capital appreciation by investing primarily in equity securities of public utilities including electric, gas, and telephone-service providers. This group includes funds that invest primarily in global communications.

REFERENCES

Baer, Gregory and Gensler, Gary, The Great Mutual Fund Trap, Broadway Books, New York, 2002.

Bernstein, William, The Intelligent Asset Allocator, McGraw-Hill, New York, 2001.

Benz, Christine, and Di Teresa, Peter, and Kinnel, Russel, Morningstar Guide to Mutual Funds John Wiley & Sons, Hoboken, NJ, 2003.

Bogle, John, Common Sense on Mutual Funds, John Wiley & Sons, New York, 1999.

Dorsey, Pat, The Five Rules for Successful Stock Investing, John Wiley & Sons, Hoboken, NJ, 2004.

Fortin, Rich, and Michelson, Stuart, "Indexing Versus Active Mutual Fund Management," Journal of Financial Planning 15, September 2002, 82-94.

Fortin, Rich, and Michelson, Stuart, "Fund Indexing Vs. Active Management: The Results Are ...," Journal of Financial Planning 12, February 1999, 74-81.

Graham, Benjamin (editorial commentary by Jason Zweig), The Intelligent Investor, Harper-Business Essentials, New York, 2003.

Jones, Michael, and Lesseig, Vance, and Smythe, Thomas, "Financial Advisors and Mutual Fund Selection," Journal of Financial Planning 18, March 2005, 64-70.

Lee, Shelley, "10 Questions with Burton Malkiel on A Random Walk Down Wall Street," Journal of Financial Planning 18, April 2005, 10-14.

Malkiel, Burton, A Random Walk Down Wall Street, W. W. Norton & Company, 8th edition, New York, 2003.

Opiela, Nancy, "The Art and Science of Mutual Fund Selection," Journal of Financial Planning 17, January 2004, 36-41.

Richard Kjetsaa, Fairleigh Dickinson University, Teaneck, New Jersey, USA

Dr. Richard Kjetsaa earned his Ph.D. in Economics at Fordham University in New York City in 1985 and was granted the professional designation of certified financial planner (CFP) in 1989. Currently, he is Associate Professor of Economics and Finance at Fairleigh Dickinson University in Teaneck, NJ. His most recent articles were published in the American Business Review. He is an officer in the Greater New Jersey Estate Planning Council.

TABLE 1: COLLECTIVE SECTOR FUND PERFORMANCE

Percentage of Funds that Outperformed Various Benchmarks

                                          Time Frame

Benchmark                       12 Months   3 Years    5 Years

Standard and Poor's 500 Index     74.2        57.8       77.4
Category Average                  44.7        47.8       49.3
Benchmark Index                   52.2        35.1       26.9

Number of Funds                   1053        818        527

                                     Time Frame

Benchmark                       10 Years    15 Years

Standard and Poor's 500 Index     31.6        35.1
Category Average                  51.1        45.8
Benchmark Index                   47.4        50.4

Number of Funds                    190        131

TABLE 2: PRECIOUS METALS FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                              Time Frame

Benchmark          12 Months    3 Years    5 Years

S&P 500 Index        95.2        100.0      97.4
Category Average     42.9         47.5      57.9
JSE Gold Index       73.8         42.5      13.2

Number of Funds        42           40        38

                        Time Frame

Benchmark          10 Years    15 Years

S&P 500 Index         0.0         0.0
Category Average     63.3        65.2
JSE Gold Index       93.3        95.7

Number of Funds        30          23

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                       Time Frames

12 Months, 3 Years, and 5 Years                                7.9
12 Months, 3 Years, 5 Years, and 10 Years                      0.0
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years            0.0

C: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, and 5 Years

      SGGDX: First Eagle Gold *
      GOLDX: Gabelli Gold *
      TGLDX: Tocqueville Gold *

Note: These funds did not have a 10-year track record

D: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

None

* Three-year Beta Coefficient less than or equal to 1.00

TABLE 3: NATURAL RESOURCES FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                   Time Frame

Benchmark              12 Months    3 Years     5 Years

S&P 500 Index            43.5        94.4        87.9
Category Average         37.6        40.3        50.0
S&P Midcap 400 Index     45.9        44.4        30.3
Number of Funds            85          72          66

                            Time Frame

Benchmark              10 Years    15 Years

S&P 500 Index             6.3         4.2
Category Average         65.6        41.7
S&P Midcap 400 Index      0.0         0.0
Number of Funds            32          24

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                        Time Frames

12 Months, 3 Years, and 5 Years                                 7.6
12 Months, 3 Years, 5 Years, and 10 Years                       0.0
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years             0.0

C: Roster of Funds that Jointly Outperformed Each benchmark:
   12 Months, 3 Years, and 5 Years

     PNRCX: Jen Natural Resources C (^)
     PNRZX: Jen Natural Resources Z
     MDGRX: Merrill Natural Resources A
     MCGRX: Merrill Natural Resources C (^)
     RSNRX: RS Global Natural Resources *

Note: These funds did not have a 10-year track record

D: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, and 10 Years

     None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

     None

* Three-year Beta Coefficient less than or equal to 1.00
(^) Expense Ratio higher than category average

TABLE 4: TECHNOLOGY FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                       Time Frame

Benchmark                  12 Months    3 Years     5 Years

S&P 500 Index                73.3         0.0        47.6
Category Average             44.2        53.3        41.9
PSE Technology 100 Index     28.8         4.7         1.0

Number of Funds               344         255         105

                                Time Frame

Benchmark                  10 Years    15 Years

S&P 500 Index                29.6        38.1
Category Average             55.6        28.6
PSE Technology 100 Index      0.0        19.0

Number of Funds                27          21

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                       Time Frames

12 Months, 3 Years, and 5 Years                                0.0
12 Months, 3 Years, 5 Years, and 10 Years                      0.0
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years            0.0

C: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, and 5 Years

None

D: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
   12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

None

TABLE 5: UTILITIES FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                       Time Frame

Benchmark            12 Months  3 Years  5 Years  10 Years  15 Years

S&P 500 Index          59.5      65.8     58.0       0.0       0.0
Category Average       51.9      51.3     52.2      47.2      36.8
Dow Jones Utility
  Index                82.3       7.9     18.8      52.8      36.8

Number of Funds         79        76       69        36        19

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                     Time Frames

12 Months, 3 Years, and 5 Years                         2.9
12 Months, 3 Years, 5 Years, and 10 Years               0.0
12 Months, 3 Years, 5 Years, 10 Years, and 15 Year      0.0

C: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, and 5 Years

FRUAX: Franklin Utilities Advisor *
FRUSX: Franklin Utilities C *

Note: These funds did not have a 10-year track record

D: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

None

* Three-year Beta Coefficient less than or equal to 1.00

TABLE 6: HEALTH FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                         Time Frame

Benchmark              12 Months  3 Years  5 Years  10 Years  15 Years

S&P 500 Index            91.8      75.2     98.6      96.7     100.0
Category Average         48.1      55.6     57.1      30.0      50.0
Russell Midcap Growth
  Index                  63.4      92.3     98.6     100.0     100.0

Number of Funds           183       117       70        30        20

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                      Time Frames

12 Months, 3 Years, and 5 Years                          20.0
12 Months, 3 Years, 5 Years, and 10 Years                13.3
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years      20.0

C: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, and 5 Years

FSMEX: Fidelity Select Medical Equipment *
RAGHX: PIMCO RCM Global Health A
RBGHX: PIMCO RCM Global Health B (^)
RCGHX: PIMCO RCM Global Health C (^)
DGHCX: PIMCO RCM Global Health D (*)
SUHAX: Scudder Health Care A
SHCAX: Scudder Health Care AARP
SUHIX: Scudder Health Care I
SCHLX: Scudder Health Care S *
PRHSX: T. Rowe Price Health Sciences *

Note: These funds did not have a 10-year track record

D: Roster of Funds that Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

ETHSX: Eaton Vance Worldwide Health A
EMHSX: Eaton Vance Worldwide Health B * (^)
ECHSX: Eaton Vance Worldwide Health C * (^)
EDHSX: Eaton Vance Worldwide Health D (^)

* Three-year Beta Coefficient less than or equal to 1.00

(^) Expense Ratio higher than category average

TABLE 7: FINANCIAL FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                         Time Frame

Benchmark              12 Months  3 Years  5 Years  10 Years  15 Years

S&P 500 Index            35.4      100.0    84.2      89.4     100.0
Category Average         37.2       36.3    40.4      47.4      66.7
S&P Midcap 400 Index     47.8       84.6    10.5      47.4      73.3

Number of Funds           113       91       57        19        15

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                      Time Frames

12 Months, 3 Years, and 5 Years                          10.5
12 Months, 3 Years, 5 Years, and 10 Years                 5.3
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years       6.7

C: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, and 5 Years

HSSAX: Emerald Banking and Financial A * (^)
FBRSX: FBR Small Cap Financial A *
TFSIX: Mutual Financial Services A *
TMFSX: Mutual Financial Services C * (^)
TEFAX: Mutual Financial Services Z *

Note: These funds did not have a 10-year track record

D: Roster of Funds that Outperformed Each Benchmark:

12 Months, 3 Years, 5 Years, and 10 Years None

E: Roster of Funds that Jointly Outperformed Each Benchmark:

12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

FSPCX: Fidelity Select Insurance *

* Three-year Beta Coefficient less than or equal to 1.00

(^) Expense Ratio higher than category average

TABLE 8: REAL ESTATE FUNDS
A: Percentage of Funds that Outperformed Various Benchmarks

                                        Time Frame

Benchmark             12 Months  3 Years  5 Years  10 Years  15 Years

S&P 500 Index           95.6     100.0     100.0     42.9      50.0
Category Average        47.8      39.6     53.0      71.4      50.0
Wilshire REIT Index     65.4      22.4     22.0      42.9      50.0

Number of Funds          159       134      100       7         2

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                   Time Frames

12 Months, 3 Years, and 5 Years                        10.0
12 Months, 3 Years, 5 Years, and 10 Years               0.0
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years     0.0

C: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, and 5 Years

CGMRX: CGM Realty
CSEIX: Cohen and Steers Equity Income A
CSBIX: Cohen and Steers Equity Income B * (^)
CSCIX: Cohen and Steers Equity Income C * (^)
******: Fidelity Real Estate High Income *
FREAX: First American Real Estate Sector A *
FARCX: First American Real Estate Sector Y *
PHRAX: Phoenix-Duff Real Estate A
PHRBX: Phoenix-Duff Real Estate B * (^)
SOAAX: Spirit of America Real Estate A * (^)

Note: These funds did not have a 10-year track record

D: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

None

* Three-year Beta Coefficient less than or equal to 1.00

(^) Expense Ratio higher than category average

****** No ticker symbol assigned by NASDAQ

TABLE 9: COMMUNICATIONS FUNDS

A: Percentage of Funds that Outperformed Various Benchmarks

                                          Time Frame

Benchmark               12 Months  3 Years  5 Years  10 Years  15 Years

S&P 500 Index             93.8      6.1     27.3      11.1      14.3
Category Average          45.8     51.5     40.9      22.2      14.3
Russell 1000 Growth
  Index                   87.5     15.2     27.3      11.1      14.3

Number of Funds             48       33       22         9         7

B: Percentage of Funds that Jointly Outperformed Each Benchmark

                                                     Time Frames

12 Months, 3 Years, and 5 Years                           4.5
12 Months, 3 Years, 5 Years, and 10 Years                11.1
12 Months, 3 Years, 5 Years, 10 Years, and 15 Year       14.3

C: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, and 5 Years

None

D: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, and 10 Years

None

E: Roster of Funds that Jointly Outperformed Each Benchmark:
12 Months, 3 Years, 5 Years, 10 Years, and 15 Years

FBMPX: Fidelity Select Multimedia