Sector fund expense ratios tend to be somewhat higher than they are for comparable funds that invest more broadly. That is, index funds investing in a U.S. sector tend to cost more to hold than index funds investing in a broad-based U.S. index, and actively managed international sector funds tend to cost more than other actively managed international funds.
Of course, extra cost alone is not reason to avoid a fund if it otherwise fits your criteria for investing. But it may be a reason not to buy a number of narrowly focused funds to achieve diversification.
Some sector mutual funds may also carry higher redemption, or exit, fees or impose them for a longer period after purchase than broad-based funds from the same investment company. If that’s the case, the goal is to prevent wholesale redemptions if the sector in question should suddenly experience a rapid downturn. Falling prices might not only prompt shareholders to sell back their shares to avoid further losses, but would in all probability require the fund to sell its holdings at a loss to have enough cash to meet redemption demands.
Active and passive sectors
In general, sector ETFs and sector index mutual funds tend to carry lower prices than actively managed funds. That, too, is in keeping with the general fee pattern. An unrelated but important advantage of an index-based approach to sector investments is that both types of funds are less vulnerable to style drift. Style drift occurs when an active manager modifies a fund’s portfolio to improve gains or limit losses that might result from sticking to the fund’s primary investment strategy.
Improving returns may be attractive in the short term, but over time it means that you may be taking on significantly more or less risk than you had anticipated in choosing a fund with a particular identity. In the case of sector funds, that deviation is compounded by the fact that your goal in choosing a particular fund is to gain exposure to its very specific investment focus.
