What Is A Sector Fund?

What is a sector fund? A sector fund is a mutual fund that concentrates on a relatively narrow market segment. Michelle Smith and the Mutual Fund Education Alliance have this definition for a sector fund,...

Michelle Smith and the Mutual Fund Education Alliance have this definition for a sector fund, "A mutual fund that concentrates on a relatively narrow market segment. These funds can experience higher volatility than some diversified funds because sector funds are subject to issues specific to a given sector." Sometimes investors use specialty funds as another name for sector funds. Ms. Smith and the MFEA define a specialty fund as "A mutual fund specializing in the securities of a particular industry or group of industries or special types of securities."

A sector is a very distinct subset of a market, economy or industry. Standard & Poor's has the market divided up into eleven sectors. The eleven sectors are utilities, consumer staples, transportation, health care, technology, financial, consumer cyclical, energy, basic materials, communications and capital goods. Of course, other groups have their own categories and may even break them down further.

Because sector funds try to keep a narrow focus, they can be very volatile and risky. They are not very diversified, so if a particular sector starts having troubles due to economics, political situations or natural disasters, the impact can be very high on your portfolio. Some investors will use a sector fund if they think it can outperform the market in general. Others may choose to use sector funds as a hedge against their other securities. Investors may hold a sector fund that specializes in precious metals as a hedge against high interest rates or other factors.

Michelle Smith and the MFEA have this to say about specialty funds, "Specialty funds are suitable for investors seeking to invest in a particular industry who can monitor industry performance regularly and alter investment strategies accordingly. Investors must be willing to assume the risk of potential loss in value of their investment in the hope of achieving substantial gains. They are not suitable for investors who must conserve their principal or maximize current income."

For the investor who is interested in a particular sector, but does not have the time or expertise to research the companies, a sector fund is a great choice. Within the sector, these funds do have diversity, as most of them tend to have between 25 and 100 stocks. So if your research pinpoints five top performing companies, choose a sector fund to gain access to them all, if they are part of it.

While sector funds can be risky, there are some things you can do to lessen the volatility. Look at the companies that make up the majority of fund. It is a better bet that a well-known industry leader will not go under, unlike a new start-up company. These companies may slump, but not as bad as a smaller one. The larger, better-managed companies tend to buy up smaller competitors, which give you a larger share. Another way to manage the risk is to find funds that are in sectors that will not go out of 'style'. Consumer products and utilities are good examples of this technique, as people will need to eat and power their homes.

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