(FORTUNE Magazine) – A new breed of mutual fund is aiming to cash in on the fast-growing service economy. These service sector mutual funds buy stocks of companies in industries such as broadcasting, banking, transportation, and health care. The first service sector fund started investing barely two years ago. Two others began operating in 1984 and a fourth was approved by the Securities and Exchange Commission in September. Betting on the services, which have grown 50% faster than the manufacturing sector for the past 20 years, seems to have worked so far. The first three service sector funds have handsomely outperformed Standard & Poor's index of 500 stocks. John Laporte, president of the newest fund, T. Rowe Price's New America Growth Fund, likes service companies because ''they are not exposed to overseas competition and to the vacillations of the dollar.'' Demographics help too. As the baby-boom generation grows older and richer, it is demanding more and more services, ranging from child care to travel to dining out. Fat returns aren't guaranteed, however. Michael Lipper, president of Lipper Analytical Services, a firm that tracks mutual fund performance, cautions that service sector funds might come up short in a raging bull market. Industrial stocks, rising from depressed levels, could outperform service stocks in a hot market, especially if the market is propelled upward by a falling dollar. The fund managers counter that their stocks are almost certain to do better over the long haul. Stocks of service companies in the S&P 500 have appreciated 55% since 1980, vs. only 31% for other stocks in the index. Capital Research & Management of Los Angeles started the first service sector fund, the New Economy Fund, in late 1983. New Economy has $437.5 million in assets and, according to Lipper, chalked up an impressive total return of 26.2% over the past 12 months, vs. 11.4% for the S&P 500. Portfolio manager James Rothenberg says he looks for fundamental values in the information, business service, and health care industries, among others. Right now he likes stocks of cable television companies, which he claims are very cheap. Two | favorites are Denver-based Tele-Communications and Comcast Corp. of Bala- Cynwyd, Pennsylvania. Rothenberg points out that they have finished building their cable systems and are ready to start pumping out cash. They might also be takeover targets, he says. Aggressive investors might prefer the Service Economy Portfolio sold by the Vanguard Group of Valley Forge, Pennsylvania, which hired Wellington Management of Boston to make the stock picks. The fund had a 25.4% total return over the past year. Service Economy concentrates on growth stocks with high price-earnings multiples. Syl Marquardt, one of the fund's portfolio managers, likes Capital Cities, which signed a deal to take over ABC earlier this year. Marquardt predicts that Capital Cities' earnings per share will jump nearly 40% next year after a meager 5% increase, to $11, this year. He also has been buying H&R Block, the income tax preparer. Marquardt says the company, with a strong balance sheet and practically no debt, has nowhere to go but up from its recent stock price of $29. Merrill Lynch's Fund for Tomorrow invests in stocks whose fortunes rise and fall with consumer demand. The fund posted a total return of 16.1% over the past 12 months. Portfolio manager Vincent Dileo is loading up on life insurance, hotel, and leisure stocks. He's particularly high on Handleman, a fast-growing company that distributes videocassettes, records, and paperbacks to department stores. He says the company should enjoy earnings growth averaging 20% for the next three years. Dileo also recommends Lorimar, a television and movie producer that has agreed to merge with Telepictures, another production company. Dileo is impressed by Lorimar's rich library of TV shows like Dallas and Falcon Crest, which should reap enormous profits in syndication. Baby-boomers are a well-educated lot, Dileo observes, and that bodes well for publishers such as the New York Times, Times Mirror, and McGraw-Hill. The chance of higher returns from the services comes at the cost of considerably less diversification than the typical mutual fund provides. Over the long run, their managers say, service sector funds should do just fine. But the ride could be a bumpy one.

CHART: MUTUAL FUND ASSETS TOTAL PRINCIPAL INVESTMENTS in millions RETURN last 12 months New Economy Fund 437.5 26.23% Long-term growth Fund for Tomorrow 265.8 16.08% Consumer products Service Economy Portfolio 16.3 25.39% High growth New America Growth Fund 4.5 N.A. Long-term growth FUNDS THAT FANCY THE SERVICES These four mutual funds invest in service industries such as airlines, banking, ublishing, and retailing, but use different criteria to pick the stocks in their portfolios.