Sector & Equity Compass
What’s the role of sector indices in risk, pricing and active returns? S&P DJI’s Tim Edwards joins Rebecca Chesworth of SPDR ETFs to explore how and why some investors are getting active with sectors.
Around half of variation in stock returns can be attributed to sector trends.
Sectors allow targeted exposure to capture opportunities in market (be it sentiment, macro factors, themes, style). Across a fund range there is also the ability to play different parts of the business cycle in different regions, e.g. US vs. Europe.
Dispersion of returns is a defining characteristic of sector investing. As different sectors have different drivers, their returns will diverge over a given period. According to S&P, the dispersion between sector returns accounts for roughly half of the dispersion between stock returns. This implies that half of the value added from picking stocks could be achieved with selecting the right sectors.
Diversification of risk1 Sector investment offers a lower concentration risk than individual stocks and helps avoid idiosyncratic risk associated with individual stocks.
Varied correlations between sectors Each sector has a different correlation with the overall market. Taking advantage of these differences could reduce risk in a portfolio.
Because sectors comprise companies with the same economic activities, there are often style characteristics in common. This knowledge can be utilised to implement an investment view, particularly related to macroeconomic factors.
Investing in sectors can align portfolios with broader market trends, giving exposure to specific factors and styles.
Sectors are particularly well suited to target certain economic variables and, when accessed through ETFs, investors can implement macroeconomic views simply and cost-effectively.2
1 Diversification does not ensure a profit or guarantee against loss.
2 Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
3 Source: State Street Global Advisors, as at 31 December 2019.