February 22, 1998

Q. Do you know of a mutual fund that operates mainly in pharmaceutical companies? Should such a fund be of interest? I would like to make a sizable investment, and then would like to add fair amounts to build up money for my retirement.

A.C., Deerfield, N.H.

A. You can find mutual funds that have portfolios concentrated in pharmaceuticals in the health care sector. The most recent report from Lipper Analytical Services Inc. lists 40 funds in the category. But precisely half of these are duplicates -- different share classes of the same funds, so the group is smaller than it at first seems. Moreover, the category includes some funds that specialize in health care delivery, and others with concentrations in biotech stocks, so the list can be pared further.

Of the funds with a substantial portfolio concentration in pharmaceuticals, and with solid long-term records, Fidelity Select Health Care, Putnam Health Sciences, and Vanguard Specialized Health Care stand out. Morningstar Mutual Funds terms these three entries ``the heavyweights'' of the category, over a five-year period, the Vanguard entry stands at the top of all three measures applied by Morningstar -- best results, lowest risk, and best overall rating.

Two other factors appeal to me. Vanguard Specialized Health Care has no sales charge, compared to a 3 percent levy for Fidelity Select Health Care and 5.75 percent for Putnam Health Sciences. More important, Vanguard maintains a large-cap value portfolio, compared to large-cap growth portfolios for the other two. This translates into a 1.1 percent yield -- thin enough, but much better than .2 percent for Fidelity and none at all for Putnam. Vanguard's portfolio also carries the lowest price-to-earnings ratio, at 31.8, which compares to 32.7 for Fidelity and 34.5 for Putnam.

If you think like me, you would take relatively small comfort in those numbers -- any way you fry it these are expensive stocks, and they have posted big gains in recent years, as demonstrated by five-year average annual growth records of 22.64 percent for Vanguard, 22.38 percent for Fidelity, and 20.29 percent for Putnam. (Over a decade, Fidelity Health Care has a small lead, with average annual returns of 23.16 percent compared to 23.06 percent for Vanguard and 19.78 percent for Putnam.) Because of those past gains, I am not enthusiastic about this sector over the short term -- although I am more optimistic about short-term prospects in this sector than for the market as a whole.

On the other hand, I think health care funds are terrific for long-term appreciation, and I have frequently advocated them for retirement portfolios. Remember the battle over health care reform early in the first Clinton administration? As far as I was concerned, the real fight ended once the argument turned away from the question of whether health care costs are reasonable, and toward how they would be paid. But I suppose loss to society did have a silver lining, and that translates into investment opportunity. I am leery of the funds that focus on health care delivery, which is the part of the system most likely to be regulated. As for biotech funds, consider that most of the companies in that field are unprofitable. These factors favor the funds with major concentrations in pharmaceuticals and medical equipment.

But even though this is my favorite sector, sector funds should be used to add spice or new elements to an already diversified portfolio, and I suggest you combine your investment in a health care fund with larger positions in more traditional offerings -- probably growth or growth and income funds. The amount of your exposure to health care funds might be determined by your age. If you are about 20 years away from anticipated retirement, I would put no more than 25 percent of your nest egg in such a fund; if you're between 10 and 15 years away, I suggest you reduce that figure to about 15 percent.

Finally, reflecting my general worry about the current market, if you're going to make a ``sizable investment,'' I suggest dollar-cost averaging, spreading your investment out over 36 to 48 months.