Seek Return and Manage Risk with Sector Investing
Sector investing is a powerful tool for investors. This article highlights common goals of sector strategies and considers the advantages that sector investing may offer investors.
What is Sector Investing?
Sectors divide the economy into groups of companies that operate similar businesses. Sector investments provide targeted exposure to these economic segments.
Signet uses these segments to apply in-depth analysis of market dynamics. This allows us to see which parts of the economy are flourishing (or lagging) and position portfolios appropriately.
Reasons to Utilize Sector Strategies
Sector investing strategies may enhance a core portfolio by seeking return opportunities or potentially diversifying portfolio risks. They can also be used to adjust a portfolio based on changing market conditions, industry trends, and business cycles.
Sector investing can help accomplish 4 important goals:
- Pursue alpha – Seek to enhance returns by overweighting attractive areas and underweighting potential laggards
- Position for business cycles – Align the portfolio with shifts in business cycles either by increasing or decreasing exposure according to how we expect each sector to perform
- Capture industry trends – Help investors benefit from shifts in industry fundamentals and growth drivers
- Harness diversification benefits – Because sectors can behave differently under varying conditions, investors can help manage risk by carefully managing sector exposures. Sector investing also limits individual stock-specific risks.
Sector Exposure has been a significant determinant of equity returns
Looking at various sources of historical stock returns in the US equity market, studies show that company-specific factors, such as earnings, sales, cash flow, account for about 57% of the variability of historical returns (see chart). Sector exposure was the second most important factor. This makes sectors compelling building blocks for building a portfolio.
Source: Fidelity Investments as of Dec 31, 2018. Based on rolling 12-month analysis of variance, which uses statistical models to attribute the variance of a variable (stock returns of the Russell 3000) to certain factors (sector, style, and market cap). The residual is attributed to company-specific factors.
How to Implement Sector Strategies?
Signet offers multiple ways to implement sophisticated sector strategies. Here are a couple:
- Enhanced Sector Rotation Portfolio (ESRP)- Sectors and industries tend to react and perform very differently in reaction to shifts in economic variables and stages of the business cycle. Historically, performance leadership among sectors has rotated frequently. This provides an opportunity to enhance returns and manage risk for astute investors.
A sector rotation strategy seeks to benefit from changing stock market leadership by aligning the portfolio with the macro environment and structural shifts in the marketplace. As the economy goes through periods of expansion, slowdown, recession, and recovery, the sector portfolio aims to rotate into sectors and industries poised to benefit.
- Thematic – There are powerful trends that are reshaping how we live and spend money, but also impacting government policies and corporate strategies. These themes could meaningfully influence financial markets for years to come and provide tailwinds for growth and profitability at certain companies, industries, and sectors. Identifying and investing in thematic opportunities can be a key driver of successful investing.
One compelling theme to consider is innovation in technology and healthcare. The current COVID-19 pandemic highlights the importance of innovation in areas such as cloud computing, cybersecurity, artificial intelligence, genomics, and immunology. We believe investors can benefit by investing in companies that focus on driving future innovation and subsequent growth in the health and tech fields.
- Using a sector-based framework to build stock portfolios can help investors achieve a variety of objectives and greater control in managing risk
- Sector-based strategies remains an underutilized strategy for investors
- Sector investing can complement a core portfolio by seeking to enhance returns or potentially diversifying portfolio risks.
- Sectors have a variety of characteristics which together can help investors achieve their goals with an efficient portfolio.
Is Sector Investing Right for You? Contact your financial advisor to discuss and learn more.