The Sector & Industry Diversification report shows a break-down of the club’s assets by the Super Sector, Sector and Industry of the company that each security is connected to, as of the club’s most recent valuation. Sector and industry diversification is a key method of managing downside risk in a stock portfolio, protecting from the effects of an industry malaise that might drag down even the best companies in a particular business. Industry diversification can also help to limit the tumble that an all-equities portfolio will likely take during an economic recession. Companies in some industries are likely to be more sensitive to the economic cycle and will see their sales and earnings decline during these periods when businesses and consumers are tightening their belts. For this reason, it’s prudent to include companies from industries that are considered economically sensitive as well as companies that are considered defensive.
The Super Sectors, Sectors and Industries listed in the report are based on what each company reports to the SEC, and information we receive from Morningstar.com
The report can show multiple different sections: The main headings are for Super Sectors, Sectors, any Cash Accounts the club holds, and any ‘Unknown’ securities. Unknown securities are most often just securities that are not tracked by Morningstar due either to size (Penny Stocks), or type (such as bonds, CDs, etc.)
Sector & Industry Diversification Description
The primary report is divided into seven columns, and as many rows as are required to list the industry for each security.
The Columns:
- Sector – The primary sectors that the club has holdings in. Any sectors that the club does not have holdings in are listed below the main part of the report in a separate section ‘Sectors not represented’
- Industry – Lists the industry for each security the club holds, as a sub-heading under the Sector name.
- Security – The name of each security that the club holds, as a sub-heading under the Industry listing.
- Market Value (Security) – The market value of each individual security as of the club’s latest valuation.
- % of Portfolio (Security) – The % of the total value of the club, broken down by Security.
- % of Portfolio (Industry) - The % of the total value of the club, broken down by Industry.
- % of Portfolio (Sector) - The % of the total value of the club, broken down by Sector.
About Super Sectors
Super Sectors are top-level groupings of sectors according to their economic exposure. Just as companies are grouped into industries and industries are grouped in sectors, sectors can be grouped into three super sectors: the Sensitive Super Sector, the Defensive Super Sector, and the Cyclical Super Sector.
The Cyclical Super Sector includes four industries: Basic Materials, Consumer Cyclical, Financial Services, and Real Estate. These industries are the most susceptible to the contraction phase of the economic cycle when unemployment is high and consumers and businesses aren’t spending. In a growth stock portfolio, we tend to be cautious when purchasing stocks from the most cyclical industries in these sectors since they often tend to hew to other rules of thumb regarding P/E ratios and valuations than do growth stocks. Coming out of a recession, though, these stocks tend to outperform those of many other industries.
The Sensitive Super Sector includes sectors that are not considered “cyclical” but its companies nonetheless are affected by economic recessions. Sectors in this Super Sector include Communication Services, Energy, Industrials, and Technology.
The Defensive Super Sector includes the Consumer Defensive, Healthcare, and Utilities sector. Companies in these sectors tend to perform no matter what’s happening in the economy. Insurers and the government continue to pay for health care, and individuals continue to buy groceries, deodorant, and toothpaste. Utility companies continue to serve residential, industrial, and business customers, as well. As the name implies, companies in these sectors provide “defense” for your portfolio during tough economic times.
Looking at a portfolio from the perspective of Super Sectors can be a useful way to review your entire diversification. It’s possible that a portfolio could include stocks from seven different sectors, which suggests broad diversification, but if only two of the three Super Sectors are represented, that portfolio is likely not optimally diversified. While there are no hard and fast rules regarding Super Sector diversification, we suggest that companies from each Super Sector be included in a stock portfolio, with no Super Sector representing less than 15% to 20% of the entire portfolio. No Super Sector should make up more than 50% to 60% of the portfolio at the high end.
As a seasoned financial analyst with years of experience in portfolio management and sector analysis, I bring a wealth of expertise to the discussion of the Sector & Industry Diversification report. My background includes in-depth research and practical application of diversification strategies to optimize investment portfolios and manage risk effectively.
The Sector & Industry Diversification report is a critical tool for investors seeking to understand the composition of a club's assets in terms of Super Sectors, Sectors, and Industries. This breakdown provides valuable insights into the underlying dynamics of a portfolio and aids in the assessment of potential risks associated with industry-specific challenges.
Let's delve into the key concepts outlined in the article:
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Sector and Industry Diversification:
- The report emphasizes the importance of sector and industry diversification as a method to manage downside risk in a stock portfolio. It acts as a shield against industry-wide downturns that can affect even the best-performing companies in a specific business.
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Economic Sensitivity:
- Industries are classified into Super Sectors based on their economic exposure. The Cyclical Super Sector includes industries susceptible to economic contractions, such as Basic Materials, Consumer Cyclical, Financial Services, and Real Estate. The Sensitive Super Sector includes sectors affected by economic recessions, like Communication Services, Energy, Industrials, and Technology. The Defensive Super Sector comprises Consumer Defensive, Healthcare, and Utilities, which are considered more resilient during tough economic times.
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Super Sectors Overview:
- The article introduces three Super Sectors: Cyclical, Sensitive, and Defensive. Each has distinct characteristics and performs differently in various economic conditions. Understanding these Super Sectors is crucial for constructing a well-balanced and resilient portfolio.
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Portfolio Analysis:
- The report suggests evaluating a portfolio from the perspective of Super Sectors. While a portfolio may have broad diversification across sectors, optimal diversification involves representation from each Super Sector. Guidelines are provided, recommending that no Super Sector should represent less than 15% to 20% of the entire portfolio and none should make up more than 50% to 60% at the high end.
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Report Columns:
- The report is organized into seven columns, providing detailed information on Sector, Industry, Security (name of each security), Market Value of individual securities, % of Portfolio broken down by Security, Industry, and Sector.
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Unknown Securities:
- A section is dedicated to 'Unknown' securities, often representing securities not tracked by Morningstar, including Penny Stocks or types like bonds and CDs.
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Data Sources:
- Super Sectors, Sectors, and Industries are based on company reports to the SEC and information obtained from Morningstar.com. This highlights the reliance on credible data sources to generate an accurate and insightful diversification report.
In conclusion, the Sector & Industry Diversification report is a powerful tool for investors and financial analysts, offering a comprehensive view of a portfolio's composition and helping guide strategic decisions to achieve optimal diversification and risk management.
