Although there are still two weeks left to the year, the 2004 sector derby is in full swing.

Leading the charge is real estate, a hot sector for a second year in a row. The average real estate fund is up a healthy 28.1% year-to-date through Dec. 3, according to Morningstar of Chicago, although several real estate mutual funds have handily beat that average.

In second place is natural resources, with the average mutual fund in this specialty sector gaining a hefty 26.5%. Rounding out the trifecta is the communications sector, which has seen most of its performance kick in during the last few months. The average telecommunications-targeted mutual fund returned a respectable 20.8%, with one fund more than tripling that performance (see accompanying chart, page 8.)

Real estate has, once again, been the best place to be invested in 2004. In fact, the real estate sector as a whole has shown positive returns for the past five years and has seen outperformance both this year and last, said Don Cassidy, senior analyst with Lipper of New York. That is very unusual for this sector, he noted.

According to Adelante Capital Management, a $3.3 billion real estate investment trust manager in Berkley, Calif., for the five-year period ended Nov. 30, the Dow Jones Wilshire REIT Index, a proxy for the performance of the real estate sector, has returned 22.3% versus the negative 1.87% return of the S&P 500 and the 7.4% return of the Lehman Brothers Aggregate Bond Index over the same period. Adelante manages the $50 million Adelante U.S. Real Estate Securities Fund, which, until earlier this year, had been managed by Lend Lease Rosen.

"Real estate over the past few years was underowned and undervalued," said Robert Promisel, a principal and vice president with Adelante. REITs had a particularly rough patch from 1998 to 1999, and then they saw returns turn positive in 2000. The sector has now worked off being oversold in the late 1990s and has moved beyond the catch-up phase, he added. Demographics are now driving investor interest in REITs, as aging Baby Boomers look to ways to boost current income. "That trend has propelled REITs up this year," Promisel said.

As the economy continues to improve, owners of commercial real estate are beginning to see a flurry of new occupants and can consequently begin raising rents, which will improve their profit margins, Cassidy said. While commercial and industrial real estate has done very well, so have retail securities, including regional malls and even local retail store properties, said James Trowbridge, co-manager of the AIM Real Estate Fund, which has posted a year-to-date return of 32.5% through Dec. 6. There have also been some good performing real estate stocks in some of the weaker sub-sectors such as the lodging and resorts area, he said.

Still Smarting

Still licking their wounds from the recent bear market, investors want investments perceived as safe and income-producing and are simply not looking for growth plays or stocks with great stories, Cassidy said. People are also realizing the benefits of diversifying a portion of assets into the real estate sector as a way to boost their overall portfolio returns, analysts agreed.

Real estate's positive performance should continue into 2005, although sector returns should be more modest and will likely be in the 7% to 10% range, Promisel predicted.

Of course, a sharp or very large spike in interest rates next year could derail the sector's returns, as investors would then pull back and consider higher-yielding investments, Cassidy said. The real estate sector could also be in peril if something occurs to push the economy back into a recession, or if the stock market has a huge run up, causing investors to once again chase equity returns. But the true scenario will likely be a middle ground, he suggested.

Second-place winner so far this year has been the natural resources sector. Within that sector, the State Street Research Global Resources Fund, an $839 million fund that is closed to new investors, has blown away the competition by returning more than 45% year-to-date through Dec. 3.

Ironically, one of this sector's best-performing funds is calling it quits. The UMB Scout Energy Fund, managed by United Missouri Bank, has seen shining performance, returning 36.5% year-to-date. But the fund is limping along with a meager $4 million, and the fund's advisor has decided to shut down, said company spokeswoman Katie McDonald. "Despite good returns, the fund is too small to be viable going forward," she said. The fund will be liquidated shortly.

Surprisingly, rounding out the top three best-performing specialty categories in 2004 is the communications sector, which has posted a five-year negative return of 11.2% through Dec. 3. But year-to-date, the sector is up more than 20%.

At the top of the pack of mutual funds catering to the communications sector is the ProFunds Ultra Wireless Fund, managed by ProFunds of Bethesda, Md. The fund is up an eye-popping 62.3% so far this year, beating the average communications-targeted mutual fund by an astounding 300%.

Actually, ProFunds has an overachieving mutual fund in each of the top three sectors this year. Each is an "ultra" fund, meaning that leverage is employed in an effort to achieve a 150% boost for each fund against its benchmark.

Overall, the communications sector, whose average fund has also been negative over the past three years, has gotten a nice boost within the past few months. That leap has been fueled by the wireless sector, said Ben Walker, senior portfolio manager with Gartmore Global Investments of London. Gartmore manages the Gartmore Global Utilities Fund, which has returned 27% year-to-date and invests 50% in telecommunications companies and 50% in utilities.

The shift toward wireless communications and cell phones replacing land lines for many individuals has meant a spike in business and profit for wireless companies, Walker noted. In addition, many non-U.S. pure-play wireless providers have surged.

Moreover, for electric utilities whose prices are highly correlated with the price of crude oil, a rise in electricity prices over the past few months has meant heftier revenues for utilities, he added.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.