EXECUTIVE SUMMARY
This paper examines the applications of U.S. sector indices in a portfolio context, from the perspective of both international and domestic investors. We shall:
- Outline the Global Industry Classification Standard (GICS®) classifications of sector and industry groups;
- Illustrate the importance of sectors in determining portfolio returns, in relative and absolute terms;
- Demonstrate the importance of the U.S. market in accessing global industries and sectors, and illustrate the growth in related products;
- Illustrate the potential applications of sectors in achieving diversification goals;
- Indicate how sectoral groupings help connect broader trends to their market effects;
- Compare the effectiveness of sector-selection and stock-selection strategies;
- Show that—in a multi-asset context—the impact of changing the mix of equity sectors can be comparable to the impact of adjusting stock and bond allocations; and
- Provide a long-term perspective on the sectoral composition of the U.S. market.
The first few sections summarize the importance and classification of sectors, offer basic examples of international applications, and highlight the growth of related products. Readers interested in more advanced topics related to tactical sector rotation strategies will find them addressed in the later sections.
GICS DEFINITIONS AND INDICES
Sectoral benchmarks have a long history. Indeed, when the Dow Jones Industrial Average® was first published in 1896, its developer Charles Dow had been publishing an 11-stock “Railroad Average” for over a decade. Ever since, industry-specific indices have been used to assess particular market segments or to anticipate nascent economic developments.
It is useful to have different degrees of granularity, for purposes of comparison: an investment in a railroad stock might be compared to the performance of a railroad index, or to a broader transportation index, or even yet to the entire industrial sector or the whole market. Over time, sector and industry indices serving the needs of both granular and broad market benchmarking purposes were developed by index providers such as S&P Dow Jones. However, the definitions of the various equity groupings remained subjective, along with the classifications of each company. We may disagree, for example, as to whether the corporate owners of an internet search engine should be classified as a technology company, or—supposing they make the majority of their revenues from advertising—as a media company. Historically, a smorgasbord of different sectoral taxonomies emerged, leading to a wide range of good-natured disagreement over which classification system was most appropriate. In August 1999, two of the leading index providers, S&P Indices (a predecessor of S&P Dow Jones Indices) and MSCI joined forces to produce the Global Industry Classification Standard (GICS). This provided a shared method that unified definitions across the two companies’ indices.
