Telecom Funds Are Back

Telecommunications-sector mutual funds disconnected from investors in the 2000-2002 bear market, but nowadays they're ringing loud and clear.

With a 9.8% return this year through Thursday, communications is second only to the natural-resources sector among fund groups tracked by investment researcher Morningstar Inc. And telecom's performance even tops hot real-estate funds on both a one-year and three-year basis.

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"If you had the guts to pick some telecom up when things looked really bad, and held on, you've done quite well," said John Coumarianos, a Morningstar fund analyst.

That's a big "if." Telecom is a highly volatile sector. Telecom funds bank on the growth of service providers and equipment manufacturers, but the communications industry is brutally competitive and plagued by short product cycles and thin profit margins.

"It's a real boom-and-bust, roller-coaster business," Coumarianos said. The average fund in the category lost 39% in 2002, for example, and rose 45% the following year, according to Morningstar. Buyers of telecom funds five years ago are barely breaking even on their investment with a meager 0.7% annualized gain in the period - the second-worst sector performance behind technology funds.

Lately the telecom sector has been attracting attention with head-turning acquisitions, part of a widespread consolidation that analysts find encouraging. Earlier this month, France's Alcatel SA (ALA) agreed to buy rival equipment maker Lucent Technologies Inc. (LU) in a $13.5 billion transaction. See full story. And in March, AT&T Inc. (T) dialed into BellSouth Corp. (BLS) for about $67 billion.

"There are favorable telecom industry trends worldwide," said David Weissman, senior telecom analyst at Zacks Investment Research Inc. "You'll see consolidation in the United States and North America, followed by consolidation in Europe."

The combination of service providers like AT&T and BellSouth ripples across the industry, Weissman added. Notably, he said, equipment makers are finding a shrinking customer base that is pushing them into their own merger deals. The consolidation eventually will trickle down to mid-sized and smaller telecom equipment companies, Weissman predicted, pointing to Tellabs Inc. (TLAB) and ADC Telecommunications (ADCT) as examples.

Consolidation aside, telecom companies boast other, more fundamental strengths. Communications firms are enjoying strong demand for the development and delivery of wireless and Internet technologies, Weissman said. And many of these companies are in better financial shape, with less debt, tighter expense controls and streamlined operations, he added.

But you may have to look outside the U.S. for the best prospects. Weissman recommends wireless providers SK Telecom (SKM) in South Korea and Mexico's America Movil SA (AMX) .

Global growth is also a major theme for T. Rowe Price Media and Telecom Fund (PRMTX) , which ranks near the top of its class on both a one-year and three-year span. Managers Henry Ellenbogen and Robert Bartolo cover Latin America with America Movil and NII Holdings Inc. (NIHD) , and have invested in India through Hutchinson Telecommunications International Ltd. (HTX) and Bharti Televentures. The fund also holds large stakes in Canadian service providers Rogers Communications Inc. (RG) and Telus Corp. (TU)

The T. Rowe Price managers also like the builders of the towers used in transmitting data over wireless networks. Ellenbogen's favorites: American Tower Corp. (AMT) and Crown Castle International Corp. (CCI) . These two companies, he said, boast "high barriers to entry, strong free-cash flow, and disciplined managements that aggressively buy back stock."

T. Rowe Price Media and Telecom, in fact, ranks high with Morningstar's Coumarianos for its strong management, geographic reach and low expenses, though he's generally cautious about the communications sector. "I'm reluctant to say things change and jump into these funds," he said, "but if you can't resist, the T. Rowe Price fund is your best bet."

Telecom exposure can also be found in three sector funds from giant Fidelity Investments: Select Telecommunications Fund (FSTCX) ; Select Developing Communications Fund (FSDCX) and Select Wireless Fund (FWRLX) . Franklin Resources, too, offers a wide-ranging Global Communications fund (FRGUX) . These large fund companies rely on a deep pool of research analysts to assist fund managers with stock picks.

Aggressive investors comfortable with concentrated sector risk might consider two offerings that use leverage in an attempt to enhance returns: ProFunds Ultra Telecommunications Fund (TCPIX) and ProFunds UltraSector Mobile Telecommunications (WCPIX) .

In addition, a brace of index-tracking exchange-traded funds cover the communications sector. These include: iShares Dow Jones US Telecom (IYZ) (MarketWatch, the publisher of this report, is a unit of Dow Jones & Co.); iShares S&P Global Telecommunications (IXP) ; PowerShares Dynamic Telecom & Wireless (PTE) , and Vanguard Telecom Services VIPERs (VOX) .

Five top-ranked telecom-sector mutual funds and ETFs

Source: Morningstar Inc. (Data as of 4/13/06)

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