In my ebook The Bedokian Portfolio, I constantly harped on diversification of
asset class and foreign financial markets, but I did not touch much on sector
diversification. In this blog post, I would share a bit on the sector aspect.
What is a Sector
According to Investopedia, sector, or
sometimes called the industry, is “… an
area of the economy in which businesses share the same or a related product or
service. It can also be thought of as an industry or market that shares common
operating characteristics”1. In the degree of diversification
for The Bedokian Portfolio, sector comes below region/country, since the same
sector could perform well in one country but may not be in another.
There are a few ways to define sectors.
One way is to classify them by primary, secondary and tertiary, which are
companies related to raw materials, processing and manufacturing, and services,
respectively, akin to a source-to-end-user process. Most investors would prefer
to use the standard “10 sectors”2, namely financials, utilities,
consumer discretionary, consumer staples, energy, health care, industrials,
technology, telecommunications and materials. These 10 sectors, in turn, could
be divided into sub-sectors. Our local stock exchange, SGX, also has its own
sector classification3.
The sector is used and analysed in the
second tier of fundamental analysis (FA) known as environmental factors. As I
had mentioned in the ebook4, the sector represents the “playing
field” of the companies involved. When conducting FA, besides analysing the
company in question, you must consider the future heading of the sector in
general as well.
Why is Sector Diversification Important
In my ebook, I had highlighted an example
using the local telecommunications sector and buying up equities of the three
companies does not equate to diversification, for any negative impact to the
sector would result in losses5. In a somewhat true fashion, when
news broke out on the authorities’ intention to grant a licence for a fourth company
back in July 2015, all three existing companies’ share prices took a hit.
On a longer term, the drop in the price
of oil for almost the past three years had brought the oil and its related
industries to a low. Consumers of oil, however, are benefiting, such as
transportation and manufacturing. It is precisely this scenario that, like
asset classes, certain sectors will perform better than others in certain
economic conditions.
Sector Diversification In The Bedokian
Portfolio
It is advisable to have a myriad of
sectors and industries for your Bedokian Portfolio, but do take note that a
sector could be quite broad and sometimes the sub-sectors within it is not
really correlated with one another (e.g. manufacturing of machinery and
manufacturing of food). As a rule of thumb, the 12% limit rule (see here)
should be used for individual companies and sector-based exchange traded funds,
in the case for equities. To a certain extent, sector diversification should be
practiced for bonds in terms of the corporate bond issuer’s industry.
REITs are a bit unique on the topic of
sector diversification as they are a hybrid of equity and property, hence for
simplistic sake it is better to have different types of REITs according to
their nature, like retail, hospitality, industrial, etc.
1 – Investopedia. What is a ‘Sector’. http://www.investopedia.com/terms/s/sector.asp
(accessed 21 Apr 2017)
2 – Kuepper, Justin. The Ten Sectors of
the Stock Market. ETFdb.com. 25 Dec 2015. http://etfdb.com/etf-education/the-10-sectors-of-the-stock-market/
(accessed 21 Apr 2017)
3 – SGX.com. Sectors are: Multi=Multi-Industry, MFG=Manufacturing,
CONS=Construction, COM=Commerce, Hotels=Hotels&Restaurants, TSC=Transport,
Storage&Comm., FIN=Finance, PROP=Properties, SERV=Services,
AGR=Agriculture, MINQ=Mining/Quarrying, EGW=Electricity/Gas/Water
4 – The Bedokian Portfolio, p88-89.
5 – The Bedokian Portfolio, p12.
