Best Sector ETF

What is a Sector ETF?

A sector ETF is an exchange-traded fund that invests in securities from a certain industry or sector. Sector ETFs often track the performance of a benchmark index reflecting a major stock market sector. For example, information technology, FMCG, healthcare and pharma, etc. Furthermore, they can also cover one of several sub-sectors or speciality domains, such as biotechnology or artificial intelligence.

Sector ETFs give investors a concentrated exposure to a specific stock market sector or industry. While investing in a sector ETF can help diversify a portfolio. Too much exposure to one sector can increase volatility and risk. Therefore, these ETFs are riskier compared to a broad market ETF that tracks BSE S&P 500.

How do Sector ETFs Work?

These ETFs invest in a variety of stocks within an industry by tracking an index. Unlike traditional ETFs, they do not track a broad market, rather, they are more concentrated. You get exposure to some of the top companies belonging to that particular sector through sector ETFs.

These ETFs enable you to invest in an entire industry and track popular indices within that industry. You do not hold shares in a corporation when you buy an ETF. Instead, the fund house owns the stocks, which then constructs a fund to track a specific index and sells the fund units to investors.

The aim of sector ETFs is to track a sector index as closely as possible. They do not aim to outperform the index. These ETFs are passively managed funds, and the portfolio construction changes only when the index composition changes. Thus, the fund manager targets to keep the tracking error as low as possible.

Who Should Invest in Sector ETFs?

When choosing a sectorETF for investment, it is necessary to define your investment goals and tenure. On the basis of your goals, risk tolerance levels and investment horizon, you can pick the right sector ETF for investment. 

For example, if you are an investor who wishes to invest in the technology sector, then the sector ETF that tracks Nifty IT is suitable. Similarly, if you wish to have exposure to any other sector, you can pick a sector ETF that tracks that particular sector.

Sector ETFs are suitable for investors with a long term investment horizon. Since these ETFs are passively managed funds, they suit investors who do not wish for active fund management. The expense ratio/ fees are low as sector ETFs are passive funds.

Furthermore, investing in a particular sector can be highly risky. Since the portfolio is more concentrated, the volatility is high. Moreover, sectors do not always perform well. A sector downturn can negatively impact the fund returns.

Thus investors who are well aware of the sector’s performance, its movements and have high-risk tolerance levels can consider investing in sector funds. However, an exposure beyond 10% to a particular sector is not advisable. 

Things to Consider as an Investor

Following are the things to consider while investing in sector ETFs:

Investment Horizon

Sector ETF funds are suitable for investors who have a long-term investment horizon. Since sector funds track stocks belonging to an industry, returns may fluctuate in the short term. However, the volatility tends to average out in the long term. Thus a long term investment horizon is necessary while investing in these ETFs.

Investment Objective

Understand the investment objective of these ETFs before investing in them. When selecting a sector ETF, you should have a clear investment strategy in mind. It is critical to choose the right ETF that aligns with your goals. For example, the sectorETF’s portfolio must be a well-diversified one.

Past Performance

Historical performance doesn’t guarantee future returns. Markets move in cycles, and so do sectors. Analyzing the past performance will help you understand how well the fund has performed across different market cycles.

Risk

These ETFs are high-risk investment options since they are more concentrated than broad market ETFs. During a sector downturn, the returns can be highly volatile and sometimes result in steep losses. Thus, it is important to understand the sector thoroughly before investing in it.  

Expense Ratio

Not all sector ETFs that track the same index perform the same way. Due to tracking errors, the performance and returns of these ETFs may vary. Before investing in a sectorETF, it is important to consider the fees, liquidity of the fund, and tracking error.

Advantages of Sector Exchange Traded Funds

Following are the advantages of investing in sectorETF funds:

• Real-Time Prices: Since these ETFs are listed on the stock market, you can buy and sell them at any time during trading hours.
• Low Cost: SectTheseor ETFs are passively managed schemes. Thus the number of transactions is less in comparison to actively managed schemes. As a result, the ETF’s fund management costs are lower. The ETF’s portfolio composition changes only when the index composition changes. Minimal research costs and portfolio turnover makes sector ETFs a low-cost investment option.
• Diversification: These ETFs have a diversified investment portfolio that tracks an index belonging to a sector or theme. Thus, you can enjoy exposure to all the stocks that form part of the benchmark index by investing in a sector ETF.
• Passively Managed Funds: These ETFs are passively managed schemes. The funds aim to replicate the benchmark index as closely as possible. Thus, the fund manager’s risk of making wrong decisions is eliminated. 

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