Global equity markets offer investors thousands of individual securities to choose from.[i] Approaching each security as if it shared no commonality with others would be a dizzying task for any equity market analyst or investor. Thankfully, there are many ways to categorise securities that can help jumpstart your analysis, in our view. One such categorisation: equity sectors. In our view, understanding them can facilitate diversification and help manage risk.
Sectors attempt to group equities by the member companies’ basic economic function. For example, oil exploration companies, natural gas producers and oil refiners all fall into the Energy sector. Now, not all sectors are so easily understood. Companies occasionally operate multiple types of businesses, blurring the line and complicating definition. But index providers can help. Two major equity index providers, MSCI and Standard and Poor’s (S&P), created the Global Industry Classification Standard (GICS) to define sectors. GICS uses revenues as a key factor to divide equities into 11 sectors, assigning sector membership based on the business segment that accounts for most of the firm’s sales.
Using 11 sectors to represent the global equity markets means sectors are broad, so GICS has 24 sub-categories called “industry groups” that classify equities into more narrowly defined segments. Exhibit 1 lists all 11 sectors and selected examples of underlying industry groups.
Equity Sectors and Industry Groups Provide Structure
Equities within the same industry group likely have more similar businesses than those in other groups within the same sector. Our research shows companies sharing similar drivers typically behave similarly—albeit to varying degrees. For a simple hypothetical example, consider: If oil prices are high and rising, oil producers in the Energy sector should benefit from increased revenue. But it should also benefit natural gas producers, as higher oil prices may drive demand for an alternative fuel as well. That said, companies that exclusively refine oil into gasoline likely respond somewhat differently—for them, oil is a cost! Identifying common drivers and market conditions that may benefit certain groups of companies can therefore help you understand which groups may or may not be in favour. If you anticipate higher oil prices ahead, you may favour producers over refiners, for example.
But, perhaps more importantly, understanding equity sectors can aid diversification, potentially reducing risk and improving the likelihood of reaching investing goals. We find that sector weightings (the percentage each sector comprises of an index) are an effective guide for investors as they decide how to distribute their assets across equities.
MSCI World Index Sectors
Getting adequate diversification—spreading your investments across a group of assets that respond to different drivers—can mean including holdings from many, if not all, these sectors. We don’t think it is wise to put most of your portfolio in one or two sectors, ignoring the rest. Again, our experience indicates to us that stocks within a sector or industry group tend to behave similarly. That may seem a plus when your portfolio is rising, but such concentration can yield declines far in excess of broad markets when markets drop. Consistently staying close to broad index sector weights is a check on your portfolio’s diversification.
This will require ongoing monitoring to account for changes to the index in the future, though. For one, industry and sector groupings aren’t static over time. GICS is often reclassified as the corporate world evolves to account for emerging industries, technologies and more. Just last year, MSCI and S&P gave GICS a makeover by creating the Communication Services sector, including all equities formerly in the Telecommunications sector, some Consumer Discretionary firms and a few major Information Technology companies.[ii] Moreover, sector weights will shift and change alongside market movement. Hence, this is not a set-it-and-forget-it exercise, in our view. You may have to prune from certain sectors that grow rapidly and reallocate to those that underperform in order to maintain balance. In this way, understanding sectors and their relative weights not only adds diversification—it gives you a risk management tool you can employ over time.
Fisher Asset Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein
[i] Statement based on the MSCI AC World Investible Market Index, which covers 98% of developed and Emerging Markets stocks by market capitalisation. This gauge had 8661 constituent stocks as of 9/5/2019, per FactSet.
[ii] “If This Is a Tech Bubble in Stocks, It’s the Expansionary Phase,” Lu Wang and Jeran Wittenstein, Bloomberg, 3 May, 2019. https://www.bloomberg.com/news/articles/2019-05-03/if-this-is-a-tech-bubble-in-stocks-it-s-the-expansionary-phase
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