The current market environment appears highly conducive to sector investing based on two variables: correlation and dispersion.
Broad-based equities have registered gains so far this year, supported by accommodative monetary and fiscal policies, encouraging economic data and higher COVID-19 vaccine rates than case rates. Yet, this is not just a broad beta rally.
The current market environment appears highly conducive to sector investing based on two variables: correlation and dispersion. Simply put, a high dispersion of returns across sectors indicates opportunities to generate alpha by correctly over- and under-weighting certain market segments. And a low pairwise correlation across sectors, where assets are moving more independently from one another, means returns are not clustered around one driving market force.
Sector return dispersion elevated
Return dispersion equates to the difference between the best- and worst-performing asset (in this case, S&P 500 GICS Sectors) within a group over a specified period. Here, we analyzed three-month and six-month return periods. As shown below, both three- and six-month return dispersions (29% and 56%, respectively) are well above the median level historically, as well as in the 80th percentile. In fact, the six-month return dispersion figure is in the 96th percentile.1 And this is not just the by-product of lopping off weaker and more similar returns, as the three-month return dispersion figure has remained above the 80th percentile for 60 consecutive days. That consistency has not been seen since 2008.
1 Bloomberg Finance L.P. as of March 25, 2021
2 Bloomberg Finance L.P. as of March 25, 2021
Correlation metrics across many pairs of assets grouped into one average.
S&P 500 GICS Sectors
The Global Industry Classification Standard is an industry taxonomy developed in 1999 by MSCI and Standard & Poor’s for use by the global financial community. The GICS structure consists of 11 sectors.
Originally Posted on April 1, 2021 – Is Now the Time for Sector Investing?
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Diversification does not ensure a profit or guarantee against loss.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Concentrated investments in a particular sector or industry tend to be more volatile than the overall market and increases risk that events negatively affecting such sectors or industries could reduce returns, potentially causing the value of the Fund’s shares to decrease.
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