How sector funds fit in your portfolio

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Q. Sector funds used to be really popular. Are they still, and can they make sense in a portfolio for diversity? Or are they just more expensive than other kinds of funds?
— Investor

A. Sector funds are still popular.

According to Morningstar, a leading fund research firm, there are several hundred distinct sector funds and exchange-traded funds (ETFs), said Andrew Novick, a certified financial planner and estate planning attorney with The Investment Connection and Brookner Law Offices in Bridgewater.

“You can find sector funds across a wide swath of fund providers, including the large fund companies such as Fidelity, Vanguard, iShares, and SPDRs, as well as the smaller players,” Novick said.

Let’s look more closely at sector funds.

A sector fund is a type of mutual or exchange-traded fund that only invests in one area of the stock market, Novick said.

Traditionally, he said, the market has been sliced into the following main sectors: Consumer Discretionary, Consumer Staples, Energy, Financials, Healthcare, Industrials, Materials, Real Estate, Technology and Utilities.

“However, there are dozens of much more niche offerings that limit their focus to subsectors of the broader sector categories,” he said. “This can include funds that only invest in companies that are involved in medical devices, semiconductors, regional banks, energy exploration, and more.”

Novick said savvy investors often look to sector funds as the building blocks of a portfolio or to boost exposure in certain areas of the market.

Sector funds provide opportunity to profit from trends if the investor chooses correctly, he said, but performance can vary widely across sectors so investors need to be careful.

Novick offered this example: Through Sept. 30, 2016, the energy sector was the top performer with a 19.5 percent return, but healthcare is at the bottom with only a 1 percent return. This contrasts with last year, when the consumer discretionary sector led the way a 10 percent return, while energy drew up the rear with a loss of more than 21 percent.

Performance of the more niche-oriented funds can be even more extreme, Novick said.

Those who really want extreme can look at leveraged sector ETFs, which magnify your returns, as well as inverse and leveraged inverse sector ETFs for betting against a particular sector, Novick said.

“These vehicles can be especially rewarding or damaging, but are really intended only for active traders and aren’t appropriate for most investors,” he said.

Investing in all of the sectors can be accomplished easily by using a fund with a more diversified mandate, including a fund that mirrors the S&P 500 Index, Novick said.

“Using broad-based funds will generally provide more consistent results and is probably a better idea for most do-it yourself investors,” he said. “For instance, the S&P 500 Index is up nearly 8 percent through Sept. 30, 2016 and was up a little over 1 percent last year.”

Novick offered this tidbit from the Investment Company Institute Fact Book 2016: The average expense ratio for all equity mutual funds is 1.31 percent versus 1.40 percent for all sector funds.

“My experience is that sector ETFs are similarly a bit more pricey that other ETFs,” Novick said. “Whether you are looking to use a mutual fund or an ETF, fees can vary widely so it pays to do some research.”

Overall, he said, the modestly higher cost of using sector funds is unlikely to discourage anyone from using them if the goal is to get gain exposure to that particular sector.

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This post was first published in October 2016. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.