Making A Buck As Banks Hook Up

Has merger mania among financial-services companies finally awakened your interest in the sector? Picking individual stocks at this stage is risky, since investors have bid up many banks, brokers, and insurers on expectations they'll be acquired. But consolidations should go on for years. So you may want to look at a financial-sector fund. It can offer access to an array of stocks that should benefit as industry players seek higher profits and greater efficiency by teaming up.

Of the 23 financial funds Morningstar tracks, nearly all have had market-beating returns over the past five years. The group's average return over the period is a tidy 26%, against the 23% for the Standard & Poor's 500-stock index. But not every financial fund is the same (table).

Given that much of the dealmaking has been among local lenders, you might want to pick a fund that focuses exclusively on regional banks. Fidelity Investments has one, as well as others that concentrate on home finance, insurance, consumer finance, and general financial services. An even better bet might be a diversified financial-sector fund. These funds offer the potential for higher returns, because they're likely to benefit from the next consolidation trend: mergers across industries, like Citicorp's pending marriage to Travelers Group. Regulations separating banks, brokers, and insurers are expected to break down over the next few years. "A financial-sector fund can give you a little more spice," says Tom Finucane, co-manager of John Hancock Financial Industries.

Davis Financial is another fund playing the broad consolidation theme. Three-quarters of its $800 million in assets are divided among banks, insurers, and diversified companies such as American Express and Travelers. The remainder is in stocks from other sectors, such as technology and retailing. The fund boasts a five-year average annual return of 27%. "It's nice to have a big shopping list from which to choose," says Ken Charles Feinberg, co-manager of the fund.

T. Rowe Price Financial Services and Invesco Strategic Financial Services rely more heavily on financial stocks but have different strategies. Invesco's fund features high turnover, with nearly half its assets in domestic banks and thrifts and the rest in other financial businesses. T. Rowe Price has fairly low turnover and only 28% of its assets in banks, according to Morningstar.

Diversified funds could turn out to be more volatile than pure banking funds. Commercial banking is a stable, slow-growth business with fairly predictable earnings. Brokers and fund companies, meanwhile, could take a big hit if the bull market ends. But with marriages taking place across industry lines, broader may be better in this arena.

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