The Many Flavors of Sector-Fund Investing

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The Many Flavors of Sector-Fund Investing

Investors have many sector funds to choose from, spanning several different categories, such as communications, consumer discretionary, consumer staples, equity energy, financials, health care, industrials, natural resources, precious metals, real estate, technology, and utilities. Some sector funds focus more narrowly, homing in on a particular subsector of an industry. For example, one popular fund is categorized as a health-care fund, but it invests in just biotech companies, which tend to have very different characteristics from medical suppliers and diversified pharma firms. Likewise, another is a telecom fund that focuses entirely on wireless service providers and gearmakers. Given their more concentrated focus, these funds could be even more volatile than the typical sector fund.

Do you need a sector fund?

Not according to John Bogle, the founder of Vanguard funds and the granddaddy of index investing, who is firm: "You could go your entire life without ever owning a sector fund and probably never miss it." (But despite this, Vanguard offers sector funds.) Bogle’s point is simply that a well-diversified portfolio doesn’t need sector funds.

Let’s take an example. One fund’s portfolio recently ranged from 2.8% in real estate stocks to about 16.7% in technology. Your other significant exposure would be almost 13.6% in financials and 13.5% in industrials. That’s pretty broad diversification, so you might not need or want to invest additionally in a sector fund—especially not one focused on bank stocks or tech firms, or anything else significantly represented in the index.

Using sector funds to diversify

This is the bringing-coals-to-Newcastle rule: If a sector is already well represented in your portfolio, why buy more of it? If you’re going to make use of a sector fund, it should add something your portfolio lacks, or it should increase your exposure to a sector that is underrepresented in your portfolio.

To determine whether you should buy more funds in a particular sector, you need to know and monitor your portfolio’s sector weightings. For example, let’s say you have a fund that owns only 3.18% in utilities. More conservative investors who like the dividends that utilities stocks often pay out might want to bump up their exposure with a utilities sector fund.