Fund Briefing: How to invest in industry sectors

17 April 2018

While you may be tempted to invest in specific sectors that you believe offer a good chance of future growth, this approach is not without risk.

If you have strong views on the outlook for different industries, then you may like the concept of sector investing. The idea is to focus money on areas you believe are set to outperform over the coming months. For example, you may be convinced technology companies are undervalued or healthcare firms will benefit from new drugs.

This approach can also help control risk as you’re targeting areas with better prospects, according to Martin Bamford, managing director of advisory firm Informed Choice.

“Rather than investing across an entire market, choosing a few sectors allows you to pursue those you believe offer the best chance of future growth,” he explains.

Mr Bamford believes a sector-focused approach may be attractive to income investors wanting to direct money towards areas paying the strongest dividends.

Over the past five years, technology and consumer discretionary areas have been the winners, according to Darius McDermott, managing director of investment firm Chelsea Financial Services. He attributes this to the fact investors have increasingly been willing to pay more for growth since the financial crisis.

“Technology has overtaken consumer staples due to rapid innovation and the recent monetisation of businesses, such as Facebook,” he explains.

“We believe that equities across the board are expensive relative to their own history, but some areas nevertheless are cheaper than the broader market,” he adds.

Looking ahead, he suggests financials and energy have underperformed over the past decade, which arguably makes them look attractive.

Mr Bamford, meanwhile, expects basic materials and commodities to perform well on the back of an expanding global economy.

“Rising oil prices should help support the performance of energy companies this year,” he says. “Expanding economies should also result in a good year for consumer sectors.”

However, Patrick Connolly, a certified financial planner at advisory firm Chase de Vere, warns there are risks of taking a sector approach.

“If you make the wrong choices, you will have more of your money invested in poor-performing areas. This will impact on the size of your investment funds,” he says.

It’s a fair point. Depending on how much of your overall portfolio is tied up in this approach, a bad selection could have an adverse effect on your longer-term standard of living.

“Investing in specific sectors is a high-risk approach, as you are increasing your exposure to particular areas – effectively having more of your eggs in the same basket,” he adds.

Mr Connolly argues that specialist sector funds sit at both the top and bottom of the performance tables, highlighting the incentives and risks involved.

“Funds investing in biotechnology sit near the top of the tables, while those investing in gold, infrastructure and real estate are at the bottom,” he says.

The reality is nobody knows which sectors will perform well or badly in the future.

“What we do know is that investing in specialist sectors is likely to lead to volatile performance, which could expose investors to significant gains or losses,” he adds.

Most investors should probably avoid getting seduced by sector funds, according to Adrian Lowcock, investment director at multimanager Architas.

“These funds tend to be driven high by momentum and then investors lose out as the hype fades and the money leaves the market,” he says.

For those who like the idea, Mr Lowcock suggests limiting exposure to 1% to 2% and having an exit strategy in place as they are rarely suitable for a buy-and-hold strategy. “Sector and thematic funds are more appropriate for more adventurous investors with larger portfolios so that a £2,000 holding is less than 1% of the portfolio,” he says.

Mr Bamford insists a core/ satellite strategy – where the bulk of money is in broader funds, with sector-focused portfolios at the edges – is sensible for anyone drawn to this idea.

“Cautious investors might want to limit sector-specific investments to 10% of their equity holdings, while higher-risk investors could comfortably go as high as 40%,” he adds.

How to invest in sectors through funds

Most UK or overseas equity funds give their investors diversified exposure to a wide range of different sectors. So, if you want to focus your investments in a specific sector, you’ll need to find a fund that has a manager who has a very strong view, or you’ll need to find a specialist fund or investment trust.

“Investment trusts tend to offer better access to sector-specific funds in areas such as biotechnology and healthcare, infrastructure, and utilities,” explains Mr Bamford.

Annabel Brodie-Smith, communications  director at the Association of Investment Companies, agrees the closed-ended structure of investment trusts makes them suitable for investing in areas such as commodities.

“Investment trust managers can take a long-term view of their portfolio, which is particularly helpful in, perhaps, a more unpredictable specialist sector,” she explains.

She also points out they’re not forced sellers when markets are volatile, unlike the managers of open-ended funds.

“Investment trusts have independent boards to look after shareholders’ interests and these directors often have sector-specific knowledge, which is another advantage,” she adds.

QUICK GUIDE: Is this area right for me?

Consider sector investing if…

  • You want to focus on specific sectors of the market
  • You want greater control over where you invest
  • You are looking for satellite holdings in addition to a broader-based fund

Fund to watch: Polar Capital Technology Trust

This trust aims to maximise long-term capital growth by investing in a diversified portfolio of technology companies around the world. The manager chooses companies on the potential for shareholder returns, focusing on factors such as management quality and the identification of new growth markets.

Internet software and services accounts for the largest exposure in the portfolio (27%), followed by software (25%) and semiconductors and equipment (15%). Other areas include electrical equipment, internet and direct marketing, IT services, communications equipment and machinery.

The US and Canada has the highest exposure (65%), followed by Asia Pacific excluding Japan (14%). Other regions include Japan (6%), Europe excluding UK (5%) and the UK (2%), with modest exposure to the Middle East & Africa, and Latin America.

There are 117 investments in the trust, with the 10 largest holdings including Alphabet (8%), Microsoft (7%), Apple (6%) and Facebook (5%).

In his most recent fund update, Ben Rogoff, the manager, said the performance of the technology sector had been encouraging. He highlighted strong balance sheets, tax reform, repatriation of overseas earnings and robust earnings growth.

“The latest high-profile example of technology disruption is Amazon’s push into healthcare (in partnership with Berkshire Hathaway and JP Morgan) and groceries (following its acquisition of Whole Foods),” he added.

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