The Best Mutual Fund Sectors

Some market sectors do comparatively better in bull markets, others in bear markets.

George Doyle/Stockbyte/Getty Images

When purchasing mutual funds, you can buy broad-based funds that invest across market sectors -- such as a fund that holds companies listed in the S&P 500 -- or you can buy sector funds that invest in a specific economic area, including consumer discretionary, consumer staples, energy, financial, health care, industrials, information technology, telecommunication services and utilities. There is no one sector that will always have the best returns. At different times in the market, some sectors will tend to do better than others.

The Market Cycle

The stock market moves forward in a never-ending cycle of economic expansion and investor confidence (bull market) followed by economic contraction and investor pessimism (bear market) Early in a bull market, growth stocks tend to outperform value stocks; later in a bull market and through a bear market, value stocks tend to do better than growth. Growth stocks are companies with recent better-than-average price, earnings and sales momentum. Value stocks are companies that analysts may under-rate and investors undervalue; in other words, they trade at a lower value than they're actually worth. Characteristics of value stocks are low price-to-earnings and price-to-book ratios and high dividend-to-share-price ratio. Book value is the value of the company's physical assets.

Relation of Sector to Cycle

In several instances, a sector will tend to do better in one part of the cycle than in another. Early in a bull market, consumer discretionaries often enjoy an advantage. Later in the cycle, consumer staples may do better. Consumer discretionary sector funds invest in companies that manufacture and sell the things we want to have, but do not absolutely need: for example, automobiles, furniture, recreational equipment and services, and designer clothing and goods. Consumer staples manufacture and market the things we need, including food, clothing and household items.

Necessity vs. Desire

The same distinction between consumer discretionaries and consumer staples -- things we'd like to have versus things we must have -- can be made for other sectors as well. Health care, for example, is clearly not optional and enjoys an advantage later in the cycle. Industrials and materials -- depending upon the companies chosen by the fund -- may do better during the expansion part of the cycle than later, when consumers tend to delay optional purchases. The energy and utility sectors manufacture and deliver goods and services we always need, and also may outperform later in the market cycle.

Other Trends

Other, non-cyclical trends may suggest fund sectors (and within the sector, funds devoted to a specialization) that will outperform others. Renewable energy funds, for example, will likely do comparatively better with a Democratic president and congressional majority; funds specializing in oil-, gas- and coal-related activities may do comparatively better with a Republican president and congressional majority. Health care is a complex issue, but also maybe analyzed in terms of political outcomes to determine, for example, which health care services will outperform with an expansion of medicare, and which may be relatively unaffected.