Foreign and sector funds can help you to diversify your investment portfolio.
Diversification is a basic investing principle that is based on avoiding putting all your eggs in one basket. If you invest in different assets whose investment returns are not correlated you will reduce the risk in your portfolio.
To the extent that foreign and sector funds help you to diversify your portfolio, you may wish to add them to your range of investment choices.
Foreign funds invest in the stocks and bonds of non-U.S. companies. Foreign funds are also called international funds. Global funds, on the other hand, invest in securities of non-U.S. and U.S. companies.
As a result, when a global fund manager turns bearish on investment opportunities outside of the U.S., they are likely to increase their allocation to U.S.-denominated investments. If your intent is to invest in companies outside of the U.S., you may wish to avoid global funds in favor of foreign funds.
Other foreign fund categories include regional and country funds. These funds further concentrate their investments to a particular region or country.
When you buy shares of a foreign fund, you also buy the currencies in which those countries operate. If your fund hedges its currency exposure, you may lose a few basis points in return for hedging costs but in exchange your portfolio is protected from fluctuating currency values.
If your fund does not hedge its foreign exposure, the fund's returns are likely to experience more volatility in returns.
Sector funds concentrate their investments in one sector of the economy. Financial services, utilities, technology and energy funds are examples of sector funds. After the technology stock bubble burst in early 2000 -- the tech-heavy NASDAQ stock index subsequently fell 80% from its high, dashing the optimism of millions of investors -- it's clear that concentrating in a single sector is bad for the value of your investment portfolio.