The Aladdin's Cave of specialist funds

These are the misfits of the investment industry, whose objectives mean they can't be accommodated by any of the mainstream sectors. In some cases, this is because they focus on niche areas; in others, it's due to how they pursue their goals. Even a cursory glance at the sector's 300-plus funds illustrates the point.

Some concentrate on sectors such as commodities and natural resources, while others are dedicated to specific regions such as Latin America or India. Previously, investors would only consider this sector if they wanted to add higher-risk niche funds to their existing portfolios, but in recent years there has been an increase in the number of multi-asset and risk-targeted funds being added to the sector.

You need to look carefully as you can't really compare these funds in any meaningful way.There has also been an uptick in the number of fund managers that end up in the Specialist sector because they don't want to be restricted by the investment rules required to remain in other sectors.

But although the sector adds variety to the investment world, these funds have both the potential to deliver stellar investment returns and to leave investors with huge losses, warns Patrick Connolly, a certified financial planner with Chase de Vere. "The wide range of funds in this sector is reflected in their varying performance figures," he says.

"Some funds have produced exceptionally strong returns, while others may well have given investors sleepless nights."

Vast differences in returns

Given the diverse nature of its constituents and their various aims and objectives, performance ranking of funds within the sector is also inappropriate. The differences in returns can certainly be huge, points out Connolly.

"Over the past five years, the AXA Framlington Biotech fund has made gains of 249%, increasing an investment of £10,000 to £34,900, while the MFM Junior Gold fund has lost 89.1%, meaning a £10,000 investment would now only be worth £1,090," he explains.

Not only do returns depend on the skill of the manager, but also global economic and political issues.Connolly's comments are backed up by statistics compiled by Morningstar to 7 December 2015. The best performing fund over the past year has been Invesco Korean Equity, which invests in Korean companies and has delivered a 17.53% return. At the other end of the scale comes BGF World Mining A2, which invests at least 70% of its total assets in the equity securities of mining and metals companies. It has fallen by a depressing 48.5% over the same period.

Sometimes these performances are due to particular areas being in - or out - of favour. For example, over the past three years it's obvious that natural resources, energy, Latin America and Eastern Europe have really struggled. However, there have been strong returns from funds focused on India, biotechnology, Australia and some financial portfolios, so not only do returns depend on the skill of the manager, but also global economic and political issues.

Approach with caution

In most cases, the best approach is to cherry-pick funds from the sector that can enhance the returns generated by a portfolio's principal holdings.This is why you need to approach the Specialist sector with caution and ensure you have a thorough understanding of a fund's aims and objectives before committing yourself, warns Darius McDermott, managing director of Chelsea Financial Services.

"There are funds in the sector ranging from Brazilian equities to thematic funds such as water - and everything in between," he says.

"So you need to look carefully as you can't really compare funds in any meaningful way."

Broadly speaking, the sector can be divided into around 20 main areas, including Latin America, Africa equity, convertibles, Australia & New Zealand equity, healthcare, India, natural resources, precious metals, emerging market equity and energy.

Building a portfolio with specialist funds

In most cases, the best approach is to cherry-pick funds from the sector that can enhance the returns generated by a portfolio's principal holdings. This is known as choosing satellite investments, which can sit on the edge of core positions.

For example, an investor might want most of their money in the UK All Companies sector but also desire limited exposure to energy, precious metals, and healthcare, along with some assets in funds that benefit from a strong performance in, say, Latin America.

However, there are alternatives to buying a fund in the Specialist sector. For example, Chase de Vere's Patrick Connolly would advise clients to invest in a broad-based emerging markets fund rather than a fund investing specifically in India, Brazil or Russia.

"We do use some multi-asset funds, although prefer to use those in other sectors where the sector restrictions mean we will have a better understanding of what a fund manager is likely to do," he says.

"Investors are able to construct a sensible and balanced investment portfolio without including any funds from this sector."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.