By : Bill Byrnes

Believe that a part of the economy will be particularly strong or a part of the stock market is undervalued?

Sector mutual funds are one way of investing in market niches. Sector funds enable you to pinpoint your investments in areas such as health care, biotech, and technology (or financials, after the Fed rate cut).

ETFs are another, but have some additional risks. The common cautionary note about sector funds is they're just that: an investment concentrated in one area, where all the companies share similar characteristics and react to macroeconomic or industry events in the same way.

Thus, sector funds offer only limited diversification - within a group but a group where all the stocks will move in the same direction, for the same reason.

Sector funds offer the advantage of professional management. The portfolio manager should be able to pick the best stocks in the sector. They are a sound way for an investor to participate in sectors where they wish to invest a small portion of their assets but don't want the risk of having to select a single stock - avoiding the needle in the haystack theory.

The hidden risk of sector funds, or more than meets the eye, is that mutual funds in the same sector may have very different investment philosophies and/or definitions of what comprises suitable investments. To illustrate this point, let's look at two top ten funds, according to Morningstar, from the Utility and the Natural Resource sectors.

The JHT Utilities Trust (JEUTX) and the Fidelity Select Utilities Growth fund (FSUTX) are both top ten ranked utility funds but they're different. JHT defines utilities to include telephone companies, such as A&T, and has a foreign stock among its ten largest holdings. The Fidelity fund is focused on power generation and delivery companies.

The two funds only have three stocks in common among their ten largest holdings. The same is true for the Blackrock Global Resources fund (SGLSX) and the Vanguard Energy fund (VGELX).

Blackrock's top holdings are focused on exploration, drilling and coal. Vanguard owns more of the traditional large integrated oil companies. They have no stocks in common among their top ten holdings.

Neither strategy in our examples of top performing utility and natural resource funds is right or wrong, they're just different. That's the point.

Before investing in any sector fund (or any mutual fund), review its stated investment objectives and its top holdings. Then you'll really understand the nature of the fund and if it's the right fund for you.

Sector funds have their place in your portfolio, not as core holdings, but as a diversified way of making targeted investments in selected niches. Lastly, don't forget sector funds carry more risk than broadly diversified (investing across many sectors) mutual funds.

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By John Foley Foley [ 21/04/2006 ]
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Though it cannot be said in general that mutual funds are always better than individual stocks, it still cannot be denied that they usually involve lower risks, less money and generally yield lower but safe returns.

It all depends on the risk attitude of the investor. This is understood clearly by looking at the disclaimer attached with any mutual fund options that are nearly identical with that applicable to any other (kind of) stock. They have their advantages and loopholes like any other form of investment. And as in other forms of investment, one has to be fully aware of potential pitfalls and while driving high with mutual funds, has to be alert enough to avoid them.

Mutual funds are seemingly the easiest and least stressful way to invest in the stock market. Quite a large amount of new money has been put into mutual funds during the past few years.

Briefly put, a mutual fund is a pool of money contributed to by individual investors, companies, and other organizations. There will be a fund manager hired to invest this cash with a primary goal that depends upon the type of fund. The manger usually diversifies in a manner such that the net average earning is expected to be considerably positive. S/he may be a fixed-income fund manager. In that case s/he would work hard to provide the highest return at the lowest risk. On the other hand a long-term growth manager should try at least to beat the Dow Jones Industrial Average or the S&P 500 in a given fiscal year.

But that is what any successful investor attempts to do, and anyone with a similar approach can be expected to make the same earnings.

It all depends really on the overall investment climate and the sectors in which funds are flowing in. Diversification is definitely a good approach when it comes to successful investing by a reasonable investor. But with mutual funds, there is that the controllers may over-diversify.

Diversification minimizes the inherent risks of stock trading by spreading out the capital over many stocks. But over-diversification is again a bad thing.

First, an investor gets into many funds that have significant mutual implications, thereby losing out on the full benefits of risk stretching that diversification affords.

Secondly, over-diversification may decrease your overall return. By hitting too many poor through mediocre funds, the investor reduces the return by missing the potential of a few well-managed funds.

It is true that mutual funds play it safe. This is because mutual funds are actively organized by a professional money manager who keeps constant checks on the stocks and bonds in the fund's portfolio. As this is her/his primary occupation, s/he can devote much more time to choosing investments than an individual investor. This provides the investor with the peace of mind that comes with informed investing without the stress of analyzing financial statements or calculating financial ratios.


But on the negative side, a mutual fund, unless open-ended, must remain confined within a fixed portfolio. Even with open ended mutual funds, the range of potential is often low as compared to what is available to an investor free to choose any stock s/he likes.

Besides, mutual funds some times come as load funds in which the investor has to pay the sales commission on top of the net asset value of the fund's shares. Also, the dollar-cost averaging strategy is just the same with mutual funds as to any common stock.

Of course, fixing such a plan can substantially reduce your long-term market risk and result in a higher net worth over a period of ten years or more.

Hence considering the stress, agony and risk that any stock may involve, mutual funds look a shade better than independent trading, if low but steady is ok for you.

Article Written By J. Foley : http://investments--trading.blogspot.com