Sector Investing Risks in Different Market Conditions

What is it about?

GICS sector investing is a popular investment style that offers increased liquidity and reduced idiosyncratic risk as compared with investing in individual stocks. This is attested by the increase in trading volumes of ETFs tracking GICS sectors. While most investors are aware of macro-economic risks associated with GICS sectors by virtue of industry type constituting the sector, information about the relative performance of sectors in different market environments is not as keenly understood. For example, most investors know that utilities and consumer staples perform well during recessions; but most are unaware of how the sectors perform relative to one another during inflationary periods or during periods of wide credit spreads. Most of the knowledge about relative sector performance is restricted to associating the economic conditions with recessionary or expansionary phases of the business cycle. Further, individual components of certain sectors behave very differently during certain market periods, forming sub-sectors within the sectors. Investors who are focused on positioning their portfolio for certain market environments may find it beneficial to concentrate their holding in that sub-sector to the extent that it meets their growth mandates while staying within risk tolerance. This work presents a detailed comparison of risk and return characteristics of the 11 GICS sectors in five market environments: business-cycle recession, rising interest rates, rising inflation, high market volatility, and wide credit spreads. Further, it dissects the behavior of individual sector components to glean information about when it may be advisable for sector investors to focus on industry groups within sectors. Looking at the current market environment and the likely evolution of macroeconomic conditions in the near future, it extrapolates the findings to make general recommendations for sector investing in the near future.

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Why is it important?

Understanding risk vs reward tradeoff in sector investing