WHAT ARE SECTOR FUNDS?
What is a sector fund?
Sector funds are referred to as Specialty funds. Sector funds have been and always will be an essential segment of the mutual fund industry. Some investors even assume that specialty funds may be the better business for the mutual fund industry. They charge higher expenses and loads than diversified stock funds. This enables them to produce a greater percentage of the mutual fund returns.
Sector funds are a variety of mutual fund that focuses their equity investing within a particular industry or sector of the economy. Some specialty funds cover widespread sectors, and others focus their investments on an industry group within a sector. The most common sectors include: energy, financial services, real estate, technology, and utilities. To be listed as a specialty fund, a fund must invest at least 25 % of its portfolio into one sector. Although the bulk of specialty funds invest all their blocks into an appropriate sector or industry. Sector funds can be unpredictable investment vehicles, especially when viewed in isolation.
This is why most investors utilize the portfolio approach when investing in sector funds. The stock prices of companies in a sector or industry move in direct correlation with one another due to casual factors.
A specialty fund’s revenue is dependent on the impact of the sector’s casual factors. These casual factors that drive the specialty fund’s returns consequently lead to the specialty fund’s level of risk.
The Importance of Investing in Sector Funds
Investors will put money into specialized funds that can enhance the performance of their investments. What makes things exciting is that there are plenty of choices for investors. When it comes to these funds, it includes small caps, high yield bond, metals and minerals and much more.
Again, the purpose of holding specialized assets is to enhance portfolio performance. That means that even a small percentage of a portfolio gets invested in several of these specialty classes as a way to enhance performance.
For example, suppose a core portfolio invests primarily in equities (say 75%), of which 50% is invested in assets that mirror the S&P 500. The remaining 25% is invested in a small cap Index like the Russell 2000. For the year, assuming that non-equity assets remain unchanged (no interest and no loss). The core equity holdings would have returned 7.4%, while the specialty asset class would have returned 8.0%. The total portfolio would have returned 6.7% versus just 5.55%. If it had not taken that extra step by diversifying further into the specialty asset class.
For risk-averse investors, these specialized asset classes often present too much volatility and uncertainty. This, in turn, leave these investors with “core” holdings. But there are still lower-risk, income-based sector funds like High Yield bonds or Global bonds. For those investors who realize the importance of diversifying out of income-producing assets. Even dividend paying assets could also be considered specialty funds. The point is simple that core holdings alone, even an income-heavy fund, will rarely provide the returns.
Some of the easiest ways to invest in sector funds, for that investor with less knowledge, is through mutual funds or Index funds. These types of investments offer a considerable amount of diversification, proper levels of research. It also requires high-quality investment management. Although many investors might overlook the importance of these qualities. Since sector funds represent only a minute part of their portfolio. Mismanaging these asset classes can have devastating consequences.
For example, a bond investor who diversifies into global government bonds would have had a tough time maintaining the pace. But it returned four years of negative performance since 2003. By investing in proper funds, the benefit to the investor is proper investment management, even if it comes at a slightly higher cost.
Investing in specialty fund is an investment strategy that most investors can easily incorporate. While it may appear like a risky proposition for many. Such diversification allows traditional portfolios to outperform their peers. Thereby rewarding the investor with a greater asset mix as well as better performance.