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What Is A Sector Fund?

What Is A Sector Fund?

A sector fund is a type of mutual fund which focuses on a specific market segment. Sector mutual funds often have increased volatility due to a decrease in portfolio diversification which comes with picking a wider range of underlying assets. When investing in a sector fund, such as technology or foreign stocks, there is an increased risk of capital depreciation over more standard mutual funds due to issues that relate to a particular sector. Generally speaking a sector fund specializes in the securities of a specific industry or group of industries or singular type of securities.

Whereas index funds such as the S&P 500 or Wilshire 5000 take a broad view approach by purchasing assets from most every company in a stock exchange, sector funds will focus on a segment of these larger indexes. Standard & Poor's has eleven sectors as part of its composition which include health care, technology, utilities, financial, consumer cyclical, consumer staples, energy, transportation, communications, basic materials and capital goods. Different indexes and markets may have their own distinct categories or subsets to further allow investor specialization when choosing investments.

By their very nature a sector fund is going to be more volatile and prone to principal loss due to a lack of diversification. If for example, an investor selects a technology sector fund then they would be susceptible to any kind of adverse news or other downturns specific to technology companies. If there is decreased global demand, manufacturing issues, political instability or natural disasters that affect technology companies then stock prices could drop dramatically. Purchasing shares in a sector mutual fund is only slightly less risky than purchasing shares directly from the companies themselves. This is important to understand because the fact that it is a mutual fund does not completely mitigate the risk of share price decreases.

In other respects, a sector fund will work identically to any other mutual fund in terms of financial disclosures, providing potential investors a prospectus and explaining all expenses and fees. Sector funds will also focus on limited portfolio diversification by purchasing shares in between 20 to 50 companies. Some sector funds may invest in less or more companies but for the most part will be consistent with a few dozen stocks. It will also be important to consider portfolio activity, also known as churn, as it relates to capital gains distributions, tax implications and trading commissions and fees.

Sector funds really are a middle-of-the-road investment which are less risky than purchasing shares of stock in an individual company but more risky than a broadly diversified index fund or ETF. Many individual investors will conduct research and contemplate purchasing shares in companies they consider to be top performers but are not confident in their abilities. By selecting a sector fund, as with any mutual fund, individual investors benefit from professional portfolio management. If a sector fund invests in some of your top picks then that may be a mutual fund worth investing in as it reflects your investment strategy. As with any investment, ask lots of questions, do your research and consider speaking with a licensed financial planner or investment professional before making any decisions.