Look at the stock fund performance rankings for almost any time frame—one year, 10 years or any calendar year—and a handful of sector funds, which concentrate on a single industry or slice of the economy, will pepper the top of the list. In 2019, for instance, seven sector funds—including Fidelity Select Semiconductors, with a 64.5% return—ranked among the 10 best-performing stock mutual funds. Over the 12 months ending in mid September, sector-focused exchange-traded funds did even better, taking all top 10 spots.
These targeted bets can be good additions to your portfolio. Sector funds allow you to invest in a long-term growth trend—renewable energy, say, or genome-related health therapies—without having to shoulder as much stock-specific risk as you would by buying shares in individual companies.
Moreover, adding a certain sector fund can inject a bit of defense or offense into your portfolio, depending on the economic environment. In a recession, for instance, makers of consumer staples (shampoo, baby-care products and such), utilities and health care stocks tend to hold up nicely. Real estate and materials firms, as well as makers of nonessential consumer goods (luxury apparel or restaurants, say), do well during economic recoveries.
Pay mind, though, to certain sector-investing dos and don’ts. Stick to small bites: Put no more than 6% of your U.S. stock portfolio in sector funds, divided evenly between no more than three different sectors, say analysts at State Street Global Advisors. Sector investing requires some ongoing monitoring, too. Keep an eye on valuations: Buy on dips, especially in those sectors that have performed well in recent months. And finally, be aware of stock concentration. Some sectors are heavily weighted in just a few companies.
We’ve highlighted the best funds and ETFs in almost every sector. In some cases, one fund stands in for two sectors. Energy in the traditional sense is not represented among our recommendations, for reasons we’ll discuss. (Returns and other data are as of September 11.)
Best Sector Funds: Communication Services
In late 2018, S&P Dow Jones Indices reconfigured its sectors to form a new one, communication services. The shuffle grouped old telecom firms AT&T (symbol T) and Verizon Communications (VZ) with prized tech stocks, including Facebook (FB), Alphabet (GOOGL) and Netflix (NFLX, and media companies such as Walt Disney (DIS), among others. But only a handful of communication services funds are truly devoted to the sector (most funds fold in tech and consumer stocks). And the sector is top-heavy: Facebook and Alphabet combined make up 40% of the S&P 500 Communication Services index.
Our favorite pure play, Fidelity Select Communication Services (FBMPX (opens in new tab), expense ratio 0.78%), is actively managed by Matthew Drukker, who centers on U.S. company stocks with big revenue growth potential. In this sector, he says, “sales growth drives earnings and cash flow more sustainably than cutting costs or shifting the business mix.” Facebook and Alphabet make up 40% of the portfolio, but the fund does not own struggling AT&T, and that has been a boon to recent performance. Since Drukker took over nearly two years ago, the fund’s 21.5% annualized return has beaten the 13.9% gain in the S&P 500 Communication Services index.
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Best Sector Funds: Consumer
Consumer stocks fall into one of two categories: staples or consumer discretionary. Staples companies, which make goods people tend to use every day, include firms such as Nestlé (food and beverages) and Procter & Gamble (household and personal-care products). Consumer discretionary companies specialize in nonessential merchandise or services. Think Nike (NKE), McDonald’s (MCD) and luxury goods maker LVMH Moët Hennessy Louis Vuitton (LVMH).
But when it comes to picking good stocks in either category, you should keep your eye on what matters most: “Who’s taking market share, and where are the dollars going?” says Jason Nogueira, manager of T. Rowe Price Global Consumer (PGLOX (opens in new tab), 1.07%). “It’s hard to make money in a consumer company that’s losing market share.”
Nogueira invests in both staples and discretionary companies. When the fund launched in 2016, the portfolio was balanced between the two sectors. Growth in e-commerce has swelled the discretionary side of the portfolio to 60% of assets. Amazon.com accounts for 14% of the portfolio.
The fund holds U.S. and foreign stocks, but in some cases, domicile hardly matters. “Adidas and Nike are similar, but one is based in Germany. Both are bets on China,” Nogueira says. But he also invests in local firms dominating a consumer trend, such as Japanese online cosmetics company istyle and high-tech Chinese grocer JD.com (JD).
The fund has returned 12.6% annualized over the past three years, which beat the typical consumer staples fund but lagged the typical consumer discretionary fund by an average of 0.6 percentage points per year. It outdid the MSCI ACWI index by an average of 5.2 percentage points per year.
For a targeted shot at internet retailing, try Amplify Online Retail ETF (IBUY (opens in new tab), $84, 0.65%). It tracks an index of U.S. and foreign companies that generate at least a majority of annual revenues from internet-based retail, travel or services. Our favorite staples ETF is Fidelity MSCI Consumer Staples ETF (FSTA (opens in new tab), $39, 0.08%). Procter & Gamble (PG), Coca-Cola(KO) and Walmart (WMT) are top holdings.
Best Sector Funds: Financials
Financial firms typically do well during an economic recovery. But even before COVID slammed the global economy, chronically low interest rates were crimping earnings. That’s one reason stocks in this sector have slumped 18.5% so far in 2020. It’s also why our choices in this sector tilt toward financial services firms that are more fee-oriented.
Consider iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI (opens in new tab), $62, 0.42%). The portfolio holds stocks in 25 firms, including capital-markets companies (Goldman Sachs), brokers (Charles Schwab) and exchanges (Nasdaq). The fund has held up better than the 9.9% decline in the S&P 500 Financials index over the past 12 months, with a 3.2% decline. And over the past three years, it beat 94% of its peers with a 7.1% annualized return. The ETF yields 1.59%.
A good actively managed option is Fidelity Select Brokerage and Investment Management (FSLBX (opens in new tab), 0.77%). The fund has done well over the past 12 months, with a 9.4% gain. Manager Charlie Ackerman is relatively new, but he’s off to a fantastic start with an 11.7% annualized return since he took over in 2018. Compare that with the 1.2% loss in the S&P 500 Financials index over the same period.
Best Sector Funds: Health Care
If the experts are right and we’re on the verge of a tidal wave of medical breakthroughs, long-term investors should consider allocating a little extra to the health care sector.
Fidelity Select Health Care (FSPHX (opens in new tab), 0.70%), a member of the Kiplinger 25, the list of our favorite no-load funds, offers a one-stop way to invest in the broad sector. Manager Eddie Yoon has run the fund since 2008 with spectacular results. Compared with other health funds, Yoon ranks among the top 13% or better over the past one, three, five and 10 years. And he has outpaced the S&P 500 Health Care index in eight of the past 11 calendar years. Baron Health Care (BHCFX (opens in new tab), 1.10%) skews more of its portfolio toward small and midsize companies than the Fidelity fund. It has only a two-year history, but it has returned 19.4% annualized since its launch, which has beaten the S&P 500 Health Care index by an average of 6.5 percentage points per year. Managers Neal Kaufman and Josh Riegelhaupt look for fast-growing companies with “open-ended opportunities in large markets and competitive advantages over peers,” says Kaufman.
The pandemic has put a spotlight on biotech stocks. “It’s clear that biotech companies will be part of the solution,” says Rajiv Kaul, manager of Fidelity Select Biotechnology (FBIOX (opens in new tab), 0.72%). But investing in biotech firms comes with unique challenges. For starters, firms tend to specialize in a particular malady. “Each disease is different, so the risks and opportunity sets vary for each company,” he says.
But Kaul revels in the research required to invest in biotech because when a new treatment works, it can be life changing. That’s one reason he favors companies with a therapy that addresses a major unmet medical need. AveXis (AVXS), for instance, has a therapy for spinal muscular atrophy, a rare and deadly genetic disease. Its one-time infusion is costly, says Kaul, but trials show it can provide profound benefits.
The fund had a rough go in 2016 and 2018. But over the long haul, its 10-year annualized return ranks among the top 13% of all health funds.
Innovation is driving earnings at medical-device companies, too. IShares U.S. Medical Devices (IHI (opens in new tab), $295, 0.42%) has a three-year 20.5% annualized return, which beat 96% of its peers. Top holdings include Abbott Labs (ABT) and Thermo Fisher Scientific (TMO).
Best Sector Funds: Industrials
After a nearly two-year funk, industrial companies are poised to rebound as the world’s economies recover post-COVID, says Jason Adams, manager of T. Rowe Price Global Industrials (RPGIX (opens in new tab), 1.05%). “Right now is an excellent time to look at the global industrial sector.”
Adams sifts through industrial companies of all sizes from all over the world, looking for what he calls “differentiated” high-quality industrial firms with durable growth prospects. To Adams, that means industrial companies that are plugged into technology. Swedish firm Hexagon, for instance, provides sensor, software and automation technologies to industrial manufacturers. Japan-based Keyence is a global leader in machine vision, which is used in such tasks as inspecting industrial products, reading characters and codes, and positioning industrial robots. These companies are on the “right side of change,” says Adams, “and are leaders in driving the industry forward on the Internet of Things and the fusion of hardware, software and connectivity.”
Adams is new to the fund—something we’d normally be wary of—but he’s not new to the sector. He has been analyzing industrial companies for nearly two decades. Since he joined longtime manager Peter Bates in March, the fund has returned 15.2%, ahead of the 6.7% gain in the typical industrials fund. Bates left the fund in June.
Best Sector Funds: Information Technology
Chances are that you already have a lot of exposure to tech stocks. The sector—the biggest one—makes up 27.5% of the S&P 500. It makes sense, then, to look beyond the usual if you want to have even more tech in your portfolio.
So instead of buying a tech fund that gives you more exposure to Apple (AAPL) and Microsoft (MSFT), for instance, consider ARK Innovation ETF (ARKK (opens in new tab), $85, 0.75%), which doesn’t own either stock. Manager Catherine Wood heads the actively managed fund, aiming to find companies that will best benefit from disruptive innovation in five broad areas: genome sequencing, robotics, artificial intelligence, energy storage and block-chain technology. Veracyte (VCYT), for example, is a genomic diagnostics company; Materialise (MTLS) makes 3-D printing software. Some funds “will own any company that mentions the word robotics,” says Ark spokesman Renato Leggi. “We take a rifle-shot approach by investing in a select group of stocks that we think will be the winners.”
Over the past three years, the ETF has returned 38.7% annualized, an average of nearly 19 percentage points per year ahead of the typical tech fund. A mutual fund version of this strategy is also available in American Beacon ARK Transformational Innovation (ADNPX (opens in new tab), 1.39%).
Best Sector Funds: Materials
Stocks in this sector find, develop and process raw materials to manufacture plastic, paper, concrete, metals and more. Sounds rudimentary, and it is—literally. But these stocks tend to beat the broad market during economic recoveries, including in 2009 and 2010. What’s more, some areas of the sector are in demand now from new technologies (batteries for electric vehicles, for instance, require lithium). But if you dip a toe in, be ready for volatility. Over the past 10 years, materials stocks were among the market’s most volatile, more so even than tech shares.
You can slice the sector finely with ETFs that focus on lithium, copper or timber (all of which have done particularly well over the past year). But we prefer to stay broad, with Materials Select Sector SPDR ETF (XLB (opens in new tab), $113, 0.13%) or iShares Global Materials ETF (MXI (opens in new tab), $72, 0.45%). Both funds have delivered above-average returns with below-average volatility. Materials Select Sector holds the 28 stocks in the S&P 500 that fall within the sector, including industrial gas companies Linde (LIN) and Air Products & Chemicals (APD), and paint company Sherwin-Williams (SHW). The ETF yields 1.88%. Global Materials holds 70% of its assets in foreign stocks. With international dividends more generous overall than U.S. payouts, its international flavor means a fatter yield of 2.02%. The ETF holds 104 stocks. Linde, Australia-based mining firm BHP Group and Air Liquide, a French industrial gas and service company, are top holdings.
Best Sector Funds: Utilities/Real Estate
Reaves Utilities and Energy Infrastructure (RSRFX (opens in new tab), 1.49%) holds mostly utilities. About 40% of its assets are in utility firms with solid renewable-energy stakes, such as NextEra Energy (NEE). Demand for renewable energy is growing, and costs are declining, says comanager Timothy Porter. “That’s a powerful economic driver.” Another 24% of the fund is made up of cable companies that Porter characterizes as “unregulated monopolies.”
But the fund has a hefty slug—more than 20% of assets—in real estate investment trusts as well. That’s considerably more than the 3% of the S&P 500 held in real estate stocks, so Reaves does double duty as our favorite real estate fund, too. The managers concentrate on what we think is the best area of the REIT business these days: data centers, which own and manage facilities for computer servers that store data.
What the fund no longer owns, despite its moniker, is energy stocks. The industry is in decline, Porter says. “Every day that goes by, the cost of building a solar plant falls, and there’s more concern about climate change and regulatory efforts to address that,” he says. “It makes fossil fuel companies less and less attractive.” We agree, which is why we are not recommending an all-energy sector bet at this time.
Over the past five years, the Reaves fund has outpaced the typical utility fund, with less volatility, too. One catch: The fund isn’t widely available in brokerage no-fee networks. TD Ameritrade is one exception. You can invest directly through Reaves by calling 866-342-7058.
Nellie joined Kiplinger in August 2011 after a seven-year stint in Hong Kong. There, she worked for the Wall Street Journal Asia, where as lifestyle editor, she launched and edited Scene Asia, an online guide to food, wine, entertainment and the arts in Asia. Prior to that, she was an editor at Weekend Journal, the Friday lifestyle section of the Wall Street Journal Asia. Kiplinger isn't Nellie's first foray into personal finance: She has also worked at SmartMoney (rising from fact-checker to senior writer), and she was a senior editor at Money.
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