Sector & Industry Diversification Report
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.
- 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.