Mutual Funds that Rode Bank Rally Are Now Choosier About Holdings

The last six months of steady price gains have been a joyride for mutual funds specializing in bank stocks, but now portfolio managers will have to figure out how to preserve those gains.

Financial services sector funds were No. 1 among equity mutual funds from January through June, soaring 28.95% in value, according to Lipper Analytical Securities Corp.

Big Winners

A number of individual funds did even better. Strategic Financial Services Portfolio was up 33.88%, the Freedom Regional Banks Fund gained 33.25%, and the Fidelity Select Regional Banks Fund rose 30.51%.

That helped soften the memory of last year's confidence-rattling 14.88% decline in the financial services funds, but wary managers are still not convinced that the bad times are over.

"We were weighted as high as 45% in bank stocks as late as mid-June, but we've since pulled back to 30% and are running 25% cash. We're conservative," said Philip Dubuque, manager of Strategic Financial Services, a no-load fund based in Denver.

He acted because "the bank stocks have climbed into the middle of their historic [price-earnings] multiple range relative to the market, and I can't find a reason right now that they should go higher."

Money Flowing out

Meanwhile, "the market has been weak and we've seen money outflows," Mr. Dubuque said. His fund swelled from $3.9 billion at yearend to over $50 million as investors scrambled to take advantage of the sharp rally in bank stocks.

But it fell back to about $40 million during June as customers, sensing that the long rally had run out of gas, redeemed fund shares to take profits.

"I think the banks are going to underperform the market," Mr. Dubuque said. "The record of the last four or five recessions shows that they do at this point in the economic cycle."

California, N.Y. Banks Dropped

The reduction in bank stocks as a portion of Mr. Dubuque's portfolio is mostly accounted for by a shift out of two California banks - Wells Fargo & Co., San Francisco, and First Interstate Bancorp, Los Angeles - and a pair of New York City banks - Manufacturers Hanover Corp. and Bank of New York.

Mr. Dubuque described himself as "lucky" in selling Wells shares at $90. That was before the San Francisco superregional shocked the investment community by announcing its pristine earnings stream would be interrupted by a large second-quarter loan-loss provision. the stock traded Thursday at $70.375.

Another bank stock investment vehicle that did very well in the first half, appreciating 30%, is Pilgrim Regional Bank Shares Inc., a $90 million closed-end fund based in Los Angeles.

Carl Dorf, its portfolio manager, said he has been "scaling back on strength" in the 48 stocks held by the fund. Many are in the Midwest, a region where loan-loss problems have been much smaller than elsewhere in the country.

They include Fifth Third Bancorp, Cincinnati; United Missouri Bancshares and Commerce Bancshares, both of Kansas City; and Manufacturers National Corp., Detroit.

Also among them is Security Bancorp, Southgate, Mich., whose stock soared this year when its management announced that the institution, among the nation's largest credit card issuers, is for sale.

"Our strategy is to buy better-quality banks with above average capital positions, below average nonperforming loans, and above average loss reserve coverage," he said. "And we own some smaller, better-quality regional banks.

"We think there will be increased consolidation in the industry and a number of these banks will likely be bought out at a premium, which will help the performance of the fund."

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