To achieve average performance, investors often buy mutual funds based on a broad market index (the S&P 500 Index, for example). Managing a fund to an index is often called "passive" management because there is no active stock selection being done by a managerthe fund simply tracks the holdings of a particular index.
Broad market indices track companies across a wide spectrum of industries, making such index funds more diversified and less volatile than single-sector funds and better able to weather downturns in any single industry. The stocks in the S&P 500 Index are selected by Standard & Poor's based on size, stability, and liquidity. This index is typically used to represent the broad U.S. market and includes a representative sampling of companies in the automotive, health care, technology, retail, financial, and other industries.
Benefits of Active Management
Active management enables fund managers to try to achieve the fund's investment objective without being tied to a particular index. Firsthand's mutual funds are actively managed. Unlike passive (index) managers, active managers may invest in promising stocks that are not included in any index. They also have the freedom to allocate assets as they see fit; in other words, they are not tied to any prescribed index weightings (e.g., by market capitalization). Similarly, active managers are able to sell companies that may be in an index but are not performing well. It should also be noted that active management carries certain risks as well, including the risk that an active manager's investment style may be in or out of favor with the market, which could reduce returns.
Narrowing the Universe
When you look at the component industries of the S&P 500 Index, you'll find some groups of industries that, over different time periods, surge past or lag behind the broad market. Sector funds invest in one specific area of the economy: technology or health care or financial services or utilities or retail, etc. By focusing a portion of your assets in sectors that enjoy strong long-term prospects, you can help position your portfolio to seek solid returns. Firsthand offers two sector funds: Firsthand Technology Opportunities Fund and Firsthand Alternative Energy Fund.
Why Buy a Sector Fund?
Adding a sector fund to your portfolio begins with your own experience and understanding of broad economic trends. Before owning any sector fund, you should feel comfortable with that sector's long-term prospects and the risks involved. You ought to consider whether you believe that the sector has the potential to outperform the broad market over the long term.
An investment in a sector fund does not, by itself, constitute a balanced portfolio and is not appropriate if your key goal is preservation of capital. Sector funds, by their very nature, are more risky investments than their more diversified counterparts. There are things you can do, however, to mitigate the risks presented by sector investments:
- Plan to invest for the long termat least three to five years.
- Depending on your goals, focus only a portion of your total portfolio in sector investments.
- Consider allocating among two or more sectors.
- Take advantage of professional sector investing expertise.