So what’s another way to add value?
Another way to out-perform the market is called sector allocation. That’s a fancy term for deciding which economic groups will perform better or worse than the overall market and overweighting or underweighting those areas. For example, some portfolio managers think that the U.S. economy has fundamentally changed and that a “new normal” of deleveraging, deglobalization, and re-regulation has set in. Consequently, they look for lower consumer spending and greater financial stress going forward. Those managers therefore are overweighting slow-growth areas like utilities and telecoms and underweighting industrials, technology, and bank stocks.
A portfolio constructed in this way might be growth oriented, looking for broad themes to drive the market, or they might be value-focused, noting depressed or extended stock prices courtesy of Mr. Market. The emphasis isn’t so much on individual companies as on broad sectors—healthcare, consumer stocks, utilities, and so on. It isn’t so much an approach, as an application of an approach.
To apply sector allocation you need to know the sector-breakdown of the market so you know what bets you’re making, and you need a vehicle to effect your convictions. In this regard, Exchage Traded Funds (ETFs) have made this method much more accessible. With ETFs one can quickly gain exposure to broad market sectors in many different areas. But be careful! There are lots of different ETFs out there and the details matter.
Sector allocation can be an effective way to approach the market. It’s one more tool to use as you think about investments.