Sector investing can be a powerful portfolio construction tool. Since economic variables and business cycles impact segments of the economy differently, sector-based investment strategies can help investors align and adjust portfolios to their objectives to accomplish four important goals:
1. Pursue alpha
Sectors have historically exhibited wider dispersion than styles. In fact, the return dispersions among sectors have been wider than among styles every year for the past two decades, and more than twice as wide on average—even when we account for style-based strategies in the small-cap universe.1
A wide dispersion and changes atop the leader board provide opportunities to deliver alpha by overweighting winners and underweighting losers.
2. Position for business cycles
The economy moves in cycles. Each phase typically exhibits characteristics that impact sectors or industries differently, meaning specific sectors may outperform or underperform during different phases. With sector-based strategies, investors can align portfolios with shifts in business cycles by increasing allocations to sectors that are favored by the current economic phase and reducing allocations to sectors facing macro headwinds. Learn more about building a sector roadmap for business cycles here.
3. Capture secular or cyclical industry trends
Because sectors are closely aligned with specific economic variables, sector-based strategies can help capture secular or cyclical industry trends based on macroeconomic relationships (interest rates, inflation, oil, and the dollar).
Consider, for example, that US regional banks have higher beta sensitivity to 10-year Treasury yields than the broader market, as represented by the S&P 500 Index (0.48 vs. 0.10). Utilities, on the other hand, have negative beta (-0.25). Investors with high conviction about the direction of long-term yield movement can use sector-based ETFs focused on regional banks or utilities to enhance the positive or negative beta exposure of their portfolios.
Sector-based strategies can also be used to capture long-term growth opportunities created by secular shifts or technological trends. For example, the pharmaceutical industry has witnessed a boom in drug innovation over the past decade, particularly in biotechnology. And right now, in terms of the market share for prescription drug sales, biotech-based products have increased from 17% in 2010 to 27% in 2018.2 Driven by this secular shift, biotech stocks have outperformed the broader health care segment by 136% and the S&P 500 Index by 186% on a cumulative basis over the same time period.
Source: FDA, Bloomberg Finance L.P., as of 12/31/2018.
4. Harness diversification benefits
Stock picking is not an easy job. An investor may get the sector call right, but the stock call wrong: Historically, over the past 15 years more stocks (34%) have underperformed their respective sector averages by more than 10% than have outperformed (28%) by more than 10%, as shown below.
Source: SPDR Americas Research, FactSet, January 2003 - December 2018 yearly average. Under/outperformance is relative to each stock’s respective S&P 500 equal weighted sector returns. Performance quoted represents past performance, which is no guarantee of future results. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. It is not possible to invest in an index.
Compared to holding a small group of stocks designed to capture thematic trends, sector investing can help achieve the desired exposure without shouldering too much stock-specific risk. For example, rather than select three or four companies focused on driverless cars to capture the boom in autonomous vehicles seek a thematic, diversified—but targeted—sector exposure focused on many of the firms innovating within that space: the core players and the supply chain providers. This approach seeks to provide targeted exposure to a theme, but mitigate stock-specific risk, in case a stock call was wrong even if the theme was right.
Consider ETFs for precise implementation of sector-based strategies
From a total portfolio perspective, considering the attributes mentioned above, sector strategies may enhance the core of a portfolio by seeking alpha opportunities or potentially diversifying portfolio risks. And there are many different ways to construct sector rotation strategies (technical, fundamental, macro-based).
ETFs allow investors to implement either simple or sophisticated strategies with significant precision. We launched the first sector suite in 1998 and today, the SPDR family covers 11 GICS® sectors and 22 industries, an active sector rotation ETF, as well as thematic sectors focused on firms driving technological innovations within certain areas such as smart transportation, clean power, and intelligent infrastructure.
1 FactSet, as of 12/31/2018.
2 World Preview 2018, Outlook to 2024, Evaluate, May 2018.
Measures the volatility of a security or portfolio in relation to the market, usually as measured by the S&P 500 Index. A beta of 1 indicates the security will move with the market. A beta of 1.3 means the security is expected to be 30% more volatile than the market, while a beta of 0.8 means the security is expected to be 20% less volatile than the market.
Global Industry Classification Standard (GICS)
A financial-industry guide for classifying industries that is used by investors around the world. The GICS structure consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries, and Standard & Poor’s (S&P) has categorized all major public companies into the GICS framework.
An investor or portfolio that invests assets into one or more sector of the economy. The Global Industry Classification Standard (GICS) consists of 11 sectors: Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, and Utilities. S&P has categorized all major public companies into the GICS framework.
The investment approach or objectives used to make choices in the selection of securities for a portfolio with the most common being value and growth for equities.
S&P Biotech Select Index
The S&P Biotechnology Select IndustryTM Index is a modified equal-weighted index that represents the biotechnology sub-industry portion of the S&P Total Markets IndexTM.
S&P 500 Health Care Index
The Health Care Select Sector Index includes companies from the following industries: pharmaceuticals; health care providers & services; health care equipment & supplies; biotechnology; life sciences tools & services; and health care technology.
S&P 500 Growth Index
A market-capitalization-weighted index developed by Standard and Poor's consisting of those stocks within the S&P 500 Index that exhibit strong growth characteristics.
S&P 500 Index
Standard and Poor's 500 Index is a capitalization-weighted index of through changes in the aggregate market value of 500 stocks representing all major industries.
S&P 500 Value Index
The S&P 500 Value Index measures the performance of the large-capitalization value sector in the US equity market. It is a subset of the S&P 500 Index and consists of those stocks in the S&P 500 Index exhibiting the strongest value characteristics.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Concentrated investments in a particular sector or industry tend to be more volatile than the overall market and increases risk that events negatively affecting such sectors or industries could reduce returns, potentially causing the value of the Fund’s shares to decrease.
Passively managed funds invest by sampling the Index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the Index.
Investing involves risk including the risk of loss of principal.
Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.