Health care has been one of the best-performing mutual fund categories for each of the last five years. It was the top fund category in 2015 and the only category besides the technology sector to gain more than 5% for the year.

This leadership has led to health care funds continually appearing in the top 10 fund list. This year, seven of the 10 top five-year performers are health care funds. But before allocating solely to health care funds, read on.

The average health care fund realized an annualized 23.7% over the last five years, as shown in Table 1. In second place is the consumer discretionary category, with a 15.7% five-year annualized return, followed by the consumer staples sector gaining 12.9%. Health care and consumer discretionary sector category averages were first and second in the five-year ranking last year as well. The industrials sector dropped from third place in last year’s five-year annualized return rankings to seventh this year, which is not surprising given the rough ride the sector had during 2015 due to falling commodity prices, currency headwinds and slowing global economic growth. The technology sector moved to fourth place, up from sixth last year, while the real estate sector moved down from fourth place last year to fifth this year. While the order has changed, the top 10 spots for five-year average return are still occupied by relatively the same sectors. The exception is the small-cap stock category, which dropped out of the top 10 to make room for the financial sector.

Equity-related categories accounted for the top 12 spots in the updated category performance list, which is the same number as last year. What did change from last year is the bottom-performing fund categories. Over the last five years, the precious metals sector has been the worst-performing category, followed by energy sector funds, natural resources/commodities sector funds and emerging stock funds. Last year, currency international bonds and short-term government bonds were among the five worst-performing fund category averages.

When a new “Top Funds Over the Last Five Years” list is created, it’s important to look at the returns that make up the new five-year performance number. This time around, five-year average performance for funds added a challenging year (2015), and dropped a good year (2010).

Of the 45 category averages in Table 1, 32 had double-digit one-year returns in 2010; conversely, no categories had double-digit one-year gains in 2015. Aside from the equity fund categories being hurt by a weakening global economic environment in 2015, several bond fund categories were affected by expectations of a rate hike in the U.S., the stronger dollar or, in the case of high-yield bonds, weakening credit quality.

Energy sector funds and natural resource/commodity funds were top performers in 2010, but they significantly underperformed in 2014 and 2015, as oil and commodity prices fell. The lesson here is that momentum can be fleeting; it’s not a good idea to chase return.

The Top 5 Funds

The five funds with the highest five-year annualized return at the end of 2015 were Fidelity Select Biotechnology Portfolio (FBIOX) up 32.6%, T. Rowe Price Health Sciences (PRHSX) up 27.0%, Janus Global Life Sciences T (JAGLX) up 24.8%, Fidelity Select Health Care (FSPHX) up 23.7%, and Vanguard Health Care Investor Shares (VGHCX) up 21.6%.

Four of these five health care-related funds were among the top five-year performers last year. But just because these funds are grouped in the same category doesn’t mean they all target the same companies.

For example, Fidelity Select Biotechnology invests in biotechnology stocks and relatively equally between large-, mid- and small-cap stocks, while the T. Rowe Price Health Sciences fund invests more than half its portfolio in large-cap stocks and some of its top holdings are pharmaceuticals companies. Fidelity Select Biotech’s top holdings include Alexion Pharmaceuticals Inc. (ALXN), Regeneron Pharmaceuticals Inc. (REGN), Vertex Pharmaceuticals Inc. (VRTX) and Gilead Sciences Inc. (GILD). T. Rowe Price Health Science’s top holdings include Allergen PLC (AGN), Alexion Pharmaceuticals, UnitedHealth Group Inc. (UNH) and Humana Inc. (HUM). Both of these funds take a growth approach to portfolio management, while the Vanguard Health Care Investor Shares fund follows a value-oriented approach.

Though Fidelity Select Biotech’s total risk index of 2.37 is much higher than the average in the guide and more than double the average of the remaining top 10 funds, its volatility has been to the upside.

Table 1. Five-Year Returns for Category Averages

New to the Top 10 List

While some of the top-performing funds over the last five years also appeared in last year’s rankings, there are several newcomers: Vanguard Health Care Investor Shares, Fidelity Select Pharmaceuticals (FPHAX), T. Rowe Price Global Technology (PRGTX), Schwab Health Care (SWHFX) and PRIMECAP Odyssey Aggressive Growth (POAGX). Three of the new top funds compete in the health care space, but technology and mid-cap growth also made an appearance.

PRIMECAP Odyssey Aggressive Growth is the only non-sector fund to make it into the top 10. As of year-end 2015, the fund invested 33.4% of its portfolio in the health care sector, 29.2% in the information technology sector and 14.8% in the consumer discretionary sector. The fund invests mainly in small and mid-cap U.S. domestic stocks, emphasizing firms with prospects for rapid earnings growth. It has been among the top-performing mid-cap funds for four consecutive years, making its total risk index of 1.37 seem less daunting. The PRIMECAP Odyssey Aggressive Growth fund has a low turnover ratio of 15.0% and a tax-cost ratio of 0.7, well below the mid-cap category average of 1.4. The fund, however, is closed to new investors.

The T. Rowe Price Global Technology fund follows a growth strategy, targeting companies that fund manager Joshua Spencer thinks are attractive. Though the fund has outperformed its category peers during the last two years, it’s important to note its significantly high turnover ratio of 228.6% and tax cost ratio of 3.6, which might make it more suitable for an account with favorable tax treatment, such as a traditional IRA or Roth IRA.

The five top five-year funds that were carryovers from last year were: Fidelity Select Biotech, T. Rowe Price Health Sciences, Fidelity Select Health Care, Janus Global Life Sciences T and Fidelity Select Retailing (FSRPX).

My Fund Underperformed, Now What?

Just because your mutual fund holdings didn’t make the top 10 list doesn’t mean that you should turn around and sell them.

Diversification is an important concept to mutual fund investing and investing in general. If you held all the funds that made the top of the list this year, you would overweight health care, which isn’t prudent.

Bond funds offer diversification benefits even though they are unlikely to have the blockbuster returns in any given year. This is commonly known as the risk/return trade-off. For example, the long-term general bond category average total risk is 0.53, significantly lower than the health care sector category average total risk of 1.55. Risk can magnify returns to the upside or downside.

In this situation, compare the top funds in a particular category to a specific fund you are monitoring. If your mutual fund holding is constantly underperforming other funds in the same category over a period of years, a change may be warranted.

Additionally, aside from five-year performance, other fund statistics and figures should play a role in the selection process for your portfolio (which you’ll read about below).

A mutual fund’s performance is entirely dependent on its holdings, which may be an obvious statement, but it is an important one nonetheless. Equally important is the concept that the market is forward-looking and that performance is driven by expectations.

Don’t chase performance: Choose funds that fit into your desired asset allocation and investment strategy, and remove funds that continually underperform their category.

Fund Listings

Table 2 shows the overall top 10 funds for the five-year period, as well as the top five-year funds for each category.

In addition to five-year performance, returns are displayed for each of the past 10 years and for the most recent bull and bear markets. Returns that are in the top 25% of all funds within the investment category are shown in boldface.

Other pertinent information presented includes yield, tax-cost ratio, risk, portfolio composition and expenses. Risk and expense numbers that are in the lowest 25% of all funds within the investment category are shown in boldface.

Leveraged Funds Excluded

Ultra, contra and similar leveraged funds are excluded from the top fund listings here. Though funds such as Rydex Dynamic NASDAQ-100 2X Strategy (RYVYX) and ProFunds Ultra NASDAQ-100 (UOPIX) have impressive five-year annualized returns (both up 30.0%), they also both plunged by 80% during the last bear market.

While such funds can be good trading vehicles when you correctly guess the future direction of the market, they also significantly penalize you for being wrong. Furthermore, their inclusion would have knocked out several funds that don’t use leverage, have greater widespread appeal and are more suitable for many investors. Table 3 is a list of the best-performing funds over the last five years that includes the leveraged funds.

Table 3. Top Funds Over Five Years, Adjusted to Include Leveraged Funds

Click here to download Table 3.

Look Beyond Performance

Five-year performance figures are very useful when evaluating fund managers because they balance consistency of performance with changing market and economic conditions. Any fund manager can get lucky over the course of a single year, but talent and a good strategy are required to outperform over a period of several years. A five-year period strikes a balance of offsetting the impact of a single year’s performance without being so long that comparisons between funds become harder because of changes in managers and objectives.

Even though five years is a good time period for fund evaluation, an understanding of market and economic history adds context to the numbers. Solely building a portfolio by selecting funds from the categories with the best current five-year performance would result in a portfolio that is heavily skewed toward domestic sector funds and domestic small-cap funds. Sector funds are dependent on the trends of the industries they track and tend to overweight the largest 10% of their holdings. Small-cap funds tend to incur more return volatility, as evidenced by the total risk index score of 1.43 for Brown Capital Management Small Company Investor Shares (BCSIX) and 1.35 for Janus Venture T (JAVTX).

Consistency of performance matters. Vanguard Strategic Equity (VSEQX) has ranked among the top mid-cap funds from 2011–2014. In contrast, while Akre Focus Retail’s (AKREX) five-year annualized return is only slightly higher (15.2% compared to 13.8%), it trailed its category peers in both 2012 and 2014.

Be sure to take the extra step of looking at how long the current manager has been running the fund. For example, Jonathan Siegmann took over as manager of Fidelity Select Defense and Aerospace (FSDAX) last October. Though the fund itself fared well last year, there is no track record to reveal how he will perform as a manager. (Tables 2 and 3 show when the current manager for each fund started.) Several Fidelity funds listed in this article have managers with short tenures.

As previously stated, you should also consider how much risk a fund’s strategy incurs. Manning & Napier Pro Blend Maximum Term Series’ (EXHAX) category risk index score of 1.48 is more than double that of global balanced bond category peer Fidelity Asset Manager 40% (FFANX), which has a risk score of 0.68. This big difference in risk exists even though the two funds’ five-year returns are not dramatically different: 6.3% versus 5.2%, respectively.

Risk is also relative to the category in which a fund operates. Fidelity Select Health Care’s total risk index score of 1.50 may seem high, but the fund’s category risk index of 0.97 shows that it incurs less risk than the average health care sector fund.

Costs Matter

Lower expenses are always preferable, though—as is the case with performance—costs are relative. A domestic fund is cheaper to operate than a fund that targets foreign investments. For example, the 0.56% expense ratio for domestic balanced fund Fidelity Puritan (FPURX) is not comparable to the 1.95% expense ratio for emerging stock fund Wasatch Emerging Markets (WAEMX).

In addition to the expense ratio, a maximum load may be listed in Table 2. A load is a fee charged for buying (front-end load) or selling (back-end load or redemption fee) a fund. These fees are often reduced or waived if the fund is held for a certain period of time or if a certain dollar amount is invested. For example, Fidelity charges a 0.75% redemption fee on shares held less than 30 days for several of its sector funds, including its top-performing health care and retail funds. Terms can vary by fund, so read the mutual fund’s prospectus for specific information about the load and other charges.

If a mutual fund is held in a taxable account, the tax-cost ratio should be considered. Since mutual funds are composed of pooled investment dollars, net capital gains are passed on to shareholders of record at the time the fund sells the security. Shareholders must pay taxes on these capital gains, regardless of whether or not they sold any shares of the mutual fund itself and regardless of how long they have owned the mutual fund.

Portfolio turnover plays a role in both expenses and tax costs, with higher levels indicative of more active trading by the fund manager. Investors seeking lower costs and/or less tax exposure may want to opt for funds with lower portfolio turnover ratios.

If costs or tax efficiency are among the key characteristics you examine when looking at mutual funds, consider an index fund. Since they don’t rely on the skills of an active manager, their costs tend to be lower. Some actively managed funds do a good job of controlling costs, however. For example, Value Line Small Cap Opportunities fund’s (VLEOX) portfolio turnover ratio is 17.0% and its tax-cost ratio is 1.4%. To put these numbers into perspective, small-cap stock funds have an average turnover ratio of 72.3% and an average tax-cost ratio of 1.5%.

Further Evaluation

Before investing in any fund, read the prospectus. Have a clear understanding of the fund’s objective, strategy, risks and cost structure.

Next, obtain the latest fund report and review the holdings. What securities are currently being held in the fund? How much of the portfolio is concentrated in each of the key holdings? If the fund manager provides commentary, read it to get additional insight.

Finally, remember that even though funds are intended to be long-term investments, you should never buy and then forget about them. Mutual funds should be periodically monitored to make sure the objective has not changed and the fund is performing as expected, given prevailing market conditions and historical performance.

Pay attention not only to current performance, but also to current performance relative to historical performance and relative to the fund’s category average. A mutual fund that lags in market conditions that it historically has done well in should receive more scrutiny than a mutual fund that is following its historical volatility trends and is producing returns similar to those of its peers.

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