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Sector Funds Trump Value

The sectors have come with different levels of risk. While energy stocks are volatile, consumer staples deliver steady results.

Because the sectors vary so much, they can be used to implement precise strategies, says Baiocchi. Say you want to turn defensive and prepare for volatile times. You can overweight steady sectors, including telecom and health care.

Or suppose you believe that the economy is about to boom. You could overweight the sectors that do the best in good times, including technology, industrials and materials. An investor who wants broad diversification can include a pair of sectors with low correlations, such as technology and utilities.

What sector funds should you use? Baiocchi likes the choices from the major providers, including iShares, SPDR, and Vanguard. For financial exposure, he recommends iShares Dow Jones U.S. Financial Sector Index (IYF), SPDR Financial Select Sector (XLF) and Vanguard Financials (VFH). But he cautions against mixing funds from the different sector families in the same portfolio. Because the companies use a variety of selection systems, a group of funds from different families may not provide the diversification that investors expect.

So far Baiocchi's research has not caused many investors to abandon their value funds. This year iShares Russell 1000 Value and Vanguard Value have each reported inflows of more than $1 billion. But Baiocchi hopes that his study will start a conversation about the role that sector funds could play in portfolios.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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