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A sector mutual fund can be defined as a type of mutual fund that makes the concentration of its investments in a particular market sector. For those who are not aware, a sector is a market slice that emphasizes its whole concentration on similar business lines. Take for instance, Wal-Mart, which is placed in the consumer services sector and any American Bank is established in the sector of financial services.
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Sector Mutual Fund Characteristics
The three primary characteristics of sector mutual funds can be classified in the following manner:
- Sector mutual funds focus on stocks that are established in a certain industry or business.
- These funds are more volatile in nature when compared to the overall stock market.
- These funds are characterized by concentrated amount of holdings.
Sector mutual funds can be used to focus on the best performing sectors of the market for the current investment environment.
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Stock Market Sectors
Standard & Poors divides the stock market into 10 major sectors for the S&P 500 stock index. Those sectors are Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecommunications Services and Utilities. There are other lists of the major market sectors, but they are all similar. Individual company stocks are classified into one of these sectors.
The major sectors can be further broken down into subsectors such as regional banking in Financials and alternative energy in the energy sector. The dividing of the stock market into sectors has spawned almost 1,000 exchange traded funds -- ETFs.
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Sources of Sector Mutual Funds
There are several funds companies which offer sector mutual funds. Vanguard offers sector funds for energy, health care, precious metals and REITs. The major player for sector mutual funds is Fidelity, with its lineup of Select Sector funds. The Select Portfolio funds are available for over 40 different sector classifications. The Select Portfolio choices include the broader market sectors and focused sectors such as Multimedia and Leisure portfolios.
The Select Sector portfolios were developed before ETF trading became the more popular choice for trying to catch the hot sectors. Using mutual funds for sector investing make sense for an investor who wants to take longer term positions in certain sectors or set up a sector focused portfolio with a schedule of rebalancing.
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Downside to Sector Funds
An investor considering some sector mutual fund investing should be aware of the pitfalls:
- Market sectors can be cyclical. Investors should research how a sector cycles and try to time making an investment near the bottom of the cycle.
- It is easy for an investor to chase the current hot sector and buy in as the sector is peaking or hitting a plateau. Sector mutual fund investing involves forecasting the future of certain sectors to pick the sectors that will outperform going forward.
- A sector mutual fund manager is committed to buying stocks in the fund's target market sector. This limits the flexibility of the fund to move assets into cash if the sector appears to be peaking.