Sector and thematic funds are designed to concentrate investor exposure in particular parts of the market. Unlike broad-market funds that invest across all industries, these funds focus either on specific sectors—such as technology, energy, or healthcare—or on themes that cut across sectors, like artificial intelligence, clean energy, or cybersecurity. The intent is to allow investors to tilt their portfolios toward certain economic trends or beliefs about future market developments.
While both sector and thematic funds are categorized as equity investments, they serve more targeted purposes than diversified core holdings. They can be used to express a tactical view, overweight a high-conviction area, or supplement a broad market allocation with additional risk and growth potential.
Sector funds: traditional industry-based exposure
Sector funds limit their holdings to companies operating within a defined industry group. The Global Industry Classification Standard (GICS), which many index providers use, breaks the market into 11 broad sectors: information technology, healthcare, financials, energy, consumer discretionary, consumer staples, industrials, materials, real estate, utilities, and communication services.
Each of these sectors tends to respond differently to various stages of the economic cycle. For example, technology and consumer discretionary sectors may outperform during economic expansion, while utilities and consumer staples often hold up better in recessions. Investors use sector funds to shift weight toward sectors they believe will outperform in a given macroeconomic environment.
These funds often track well-established indexes such as the S&P 500 sector indices, and many ETFs now offer low-cost access to each of these sectors. Investors looking for precision in allocation—either to overweight or avoid certain sectors—can do so more easily through these vehicles than by managing individual stock positions.
Thematic funds: broader narratives, narrower bets
Thematic funds go beyond traditional sector definitions. Instead of grouping companies by industry, they group them by shared participation in an overarching idea or trend. A thematic fund might include companies from multiple sectors that contribute to a theme like “electric vehicles” or “aging population.” These funds are often constructed based on long-term macro or demographic trends rather than near-term industry performance.
Unlike sector funds, thematic funds are more loosely defined. Thematic investing often relies on a narrative—the belief that a certain trend will reshape part of the economy and that companies aligned with that trend will benefit disproportionately. Examples include robotics, blockchain, clean water, genetic research, and digital infrastructure. Thematic funds are usually more concentrated, less diversified, and more volatile than sector funds or broad-market portfolios.
Because they rely on an idea rather than a standardized index, these funds often involve more subjective inclusion criteria, proprietary screening methods, and higher fees. They are typically more actively managed or index-like only in name. The variability among thematic funds, even on similar topics, can be significant.
Risk and return characteristics
Sector and thematic funds carry higher risk than broad-based index funds because of their concentration. They tend to be more volatile and are more sensitive to company-specific or industry-level events. A policy change, regulatory shift, or sudden technological development can have an outsized impact on performance.
That same concentration, though, can deliver stronger returns when the underlying sector or theme outperforms the market. A technology fund, for instance, would have significantly outperformed the broad market during the 2010s but also dropped more sharply during correction periods. Thematic funds often behave similarly, with strong momentum when the narrative is in favor and severe underperformance when sentiment shifts.
Investors using sector or thematic funds should be prepared for variability in returns and should avoid relying on past performance as a predictor of future results. Because many of these funds launch at the peak of public interest in a theme, they can be subject to significant inflows at inopportune times and underperform thereafter.
Role in portfolio construction
Sector and thematic funds are generally best used as satellite holdings—not core portfolio positions. Most investors use them to complement a core allocation to broad index funds. For example, an investor might hold a total market fund as a base and use sector funds to overweight technology and healthcare. Another investor might allocate a small percentage of their portfolio to a thematic clean energy fund based on personal conviction or market outlook.
Using these funds in moderation can help tailor exposure and add growth potential. However, allocating too much to concentrated areas increases risk and introduces portfolio imbalances. Investors should be cautious about overbuilding around themes or sectors that are currently popular but may not offer lasting performance advantages.
In tax-advantaged accounts, the potential volatility of sector and thematic funds can be more tolerable since gains are not taxed annually. In taxable accounts, investors should monitor for high turnover or capital gains distributions, particularly in actively managed thematic funds.
Costs and fund structures
Sector ETFs are widely available and often inexpensive, with many charging expense ratios well below 0.20%. These funds track established indexes and operate efficiently. Thematic funds, on the other hand, are more likely to be actively managed or tied to proprietary indexes and often charge higher fees, sometimes in the 0.50% to 1.00% range or more.
Some thematic funds also have less liquidity, wider bid-ask spreads, and fewer assets under management, increasing their trading costs and risk of fund closure. Investors should also be mindful of fund age—newly launched funds may not have enough performance history to evaluate properly.
When selecting a fund, whether sector-based or thematic, reviewing holdings is important. Funds with similar names may hold very different portfolios. For instance, two clean energy funds may differ in whether they include nuclear, battery technology, or utility companies. Thematic funds may hold companies only loosely connected to the advertised theme, depending on how inclusion rules are set.
For cost-conscious investors, especially those avoiding sales charges or distribution fees, a list of no-load sector and thematic funds can be found on the main page.
Final thoughts
Sector and thematic funds are tools for targeted exposure. They are not essential for building a diversified portfolio, but they allow for expression of conviction and participation in concentrated growth areas. They are best used intentionally, with an understanding of their risk profile, volatility, and limitations.
Investors who use these funds should keep allocations modest, monitor performance relative to broad benchmarks, and be wary of overreacting to short-term narrative shifts. Used properly, they can enhance a portfolio’s potential—but they should not replace the foundation of long-term, diversified investing.