Should you ever buy sector funds? Do they have any place in your portfolio? For the longest time, I have thought that they were too risky. A sector can run so hot and cold that you are far more likely to buy the top of a sector and sell at the bottom, as I saw so many times in the last 10 years when it came to international funds, telco funds, oil service funds and, in the early 90s, biotech funds and, worst of all, gold funds.
At the same time, I think that people can use these instruments as a part of the portfolio if they are nimble. I think it is possible to trade sector funds for short-term quarter-to-quarter gains. Here's how I would do it. If you have identified a sector that is very, very hot and is in its first quarter of outpeformance vs. all other sectors, you can game that. You can put money with sector funds that exploit that theme. But two quarters later, I think you have to reevaluate and maybe even get out, because there is a cycle to these things. Once everyone recognizes that a sector is hot, too many managers come in and bid stocks up to unreasonable levels. That's when you have to leave.
You may leave something on the table when you exit, but you will most certainly will give back what you made if you stick around too long. That's fine if you are a trader. Here's the problem. I don't trade mutual funds. I own them. I don't want to have to worry about selling a mutual fund unless a manager leaves or a record turns sour for six or seven quarters. These sector funds, by nature, simply don't fit in to my long-term worldview. But I understand the desire to be in something hot. If you use my two-quarter rule, you will at least not give it back when the sector inevitably cools.
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at