Some strategies to help you diversify your portfolio across different sectors
To achieve ample diversification , investors invest across different sectors and market capitalisations. A buoyant market doesn't mean that all sectors fare well. Similarly, a falling market doesn't imply that all sectors under-perform. Stocks of some sectors remain steady even in adverse market conditions and recover fast when the sentiment improves. The real challenge is to evaluate and identify sectors that can withstand market turbulence and yield good returns.
There are many sectors including consumer goods, healthcare, financial services, telecommunications, information technology, energy, business services, auto, infrastructure and construction. Sectors whose performances are in tune with the overall economic growth and have a longterm earnings potential make good equity investments.
Investors who are unsure of evaluating different sectors can employ the 'equal weight sector' strategy to make investment choices.
Equal weight sector strategy
The basic premise behind the equal weight sector strategy is that all sectors do not outshine year after year. While some sectors may fare well this year, the remaining could out-perform next year.
Invest in each major sector represented in the market index in equal proportions. Your portfolio is equally exposed to all major sectors through their various phases of peaks and troughs. Periodically rebalancing the sectors allows you to tap profits from outperforming sectors and reinvesting in under-performing sectors that are expected to rebound.
This strategy helps you beat market volatility. However, track your trading expenses that could eat into your portfolio's returns.
Cyclical sectors
When the economy progresses across various phases of slow down, recovery and growth, some investors dynamically alter their investment strategies. The potential of various sectors changes with inflationary forces, liquidity, currency value, global influences, government policies and demand-supply situation.
The performance of cyclical sectors is sensitive to economic cycles. These sectors follow their own upward or downward trends during a given phase of the cycle. Technology, capital goods, financial, communication and infrastructure are some cyclical sectors.
Defensive sectors
Consumer necessities, healthcare and utilities are classified under defensive sectors and are less vulnerable to fluctuations in economic cycles. Hence, these sectors offer the much-needed stability to your portfolio, especially in volatile patches. You can pick good stocks by comparing their earnings with their peers across the same sector. Further, diversifying across sectors minimises the chances of losing your entire investment in case the sector you are heavily invested in fumbles.
Correlation of sectors
Some sectors exhibit high correlation in performance under similar economic conditions. Investors may not achieve the desired diversification if they invest across sectors that have high correlation. The future of a sector is marked by its growth in the domestic market, ability to capture global market share, innovations, job creation potential, embracing new technology and availability of raw material.
A portfolio heavily invested in sectors with high correlation would be marked with extreme volatility.
