The indices are equally weighted performance indexes, employed by many hedge fund managers as a benchmark for the funds they manage. Funds are assigned in categories based on the descriptions in their offering memoranda.
Another way to determine the sector breakdown of a portfolio of funds is to use returns-based style analysis in which the fund’s historical returns are regressed against the returns of a set of passive benchmarks, in this case sector benchmarks, to determine the exposures of the fund to different sectors of the economy.
Sector specialists usually hold long and short positions in stocks of companies with similar products or markets as that of the long positions. Alternatively, sector specialists may short a sector index. Net exposure of sector portfolios may range from net long to net short across managers and across time.
In a rising environment for a particular sector, managers may increase their net long position hoping that their long positions will appreciate more than the broad sector, and their short positions will appreciate less. Conversely, in a falling market, managers hope their shorts will fall faster than the broad sector.
A sector portfolio usually consists of "core positions" and "trading and hedging positions". The core positions are usually held for a long period whereas trading and hedging positions account for most of the portfolio turnover.
By taking positions in specific sectors, an investor is betting that these sectors will outperform the general market. Sector funds can be attractive as they allow investors to participate in companies they perceive to be in a faster-growing segment of the economy.
Even mediocre companies can produce high returns in periods of broad sector outperformance. The availability of sector strategies allows the investor to do his/her own diversification and choose managers with desired risk-reward characteristics.
The limited focus of sector specialists is another advantage because specialists get to know their universe of stocks very well and can unlock some of the highest value in that sector. On the downside, sector funds can be volatile because companies within them can be highly correlated. The strategy’s profitability often depends on business cycles.