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Sector Risks
There are two types of risks in equity investing: systematic and nonsystematic. Systematic risk, which is inherent in the equity market, is the possibility that the general market will underperform its historical average. Because this kind of risk applies to all securities, it cannot be diminished or eliminated by diversification.

Nonsystematic, or selection risk, is company and industry specific. It is a diversifiable risk that may be greatly reduced by owning various types of securities. Because sector fund holdings are concentrated in similar industries, they cannot be diversified across the entire economy. Therefore, nonsystematic risk is still a factor, increasing the volatility of sector funds versus a broadly diversified fund.

Do Sector Funds Offer Better Performance?
The holdings of sector funds are strongly correlated with each other. They react similarly, either positively or negatively, to external factors. When the market conditions are favorable to specific industries, the respective sector funds may outperform. At any given time, sector funds can be among both the best and the worst performers.

Historical Volatility
Due to the higher nonsystematic risk, a sector investor should be prepared for additional volatility and should have a moderate to high tolerance for investment risk. Standard deviation is another common measure of risk (or volatility) and can be used to try to calculate the possible range of returns for a fund. When a fund has a high standard deviation, the calculated range of performance is wide, illustrating greater volatility.

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