The Motley Fool

Which Sectors Should Your Investment Portfolio Be Exposed To?

This is my third article on portfolio construction, following Part 1 and Part 2, and I will be discussing an investment portfolio from an industry-exposure perspective.

The aim is two-fold: To ensure that our portfolio’s performance is maximized through exposure to growing sectors, and to buffer the portfolio on the downside in case of a recession by having exposure to resilient sectors. There should also ideally not be concentration in too few sectors, as concentration may have a pronounced effect on the portfolio should any of these sectors do poorly. In addition, there should preferably be limited exposure to cyclical sectors, as the boom-bust economic cycle tends to be accentuated in these cases. Let us delve a little more into each of the aspects mentioned above.

Choosing industries to be exposed to

The main idea in constructing an investment portfolio is that we want to have exposure to a wide variety of industries, some of which are growing and others which may be resilient. For industries in which there are long-term structural growth trends, you may wish to gain exposure to them by investing in shares in companies in these industries. Some examples which I highlighted in an earlier article include the Internet of Things, e-Commerce, and an ageing population.

As for resilient industries, these include healthcare, consumer staples, and education – these are areas in which people will still spend on, despite a recession.

Industries to be cautious of

I think investors should be cautious of sectors which are notoriously cyclical, such as those related to commodities, electronics (semi-conductors, for instance) and real estate. Exposure to such industries should be kept small – although the booms could be glorious, the busts could be brutal.

Unless you have superior insight into such industries, it is best to keep your exposure small so that the risks are contained – a sudden and unexpected blow-up would then not have adverse consequences on your entire portfolio.

How to weight the industries

Weighting now comes into play, as each company should be assessed for its sector exposure and weight within the portfolio. If Company A has a 50% exposure (by revenue) to the cyclical oil & gas industry and is 5% of your portfolio, while Company B has a 10% exposure to the same industry and has a 2% portfolio-weight, you have to add up the weighted exposure (50% x 5% + 10% x 2%) to get a blended exposure of 4.5% to the oil & gas industry.

After doing the simple mathematical exercise above, we can then review the various exposures and weights to see if we have excessive exposure to any particular industries in our portfolio. If there is over-exposure, the weights of each position can then be tweaked and adjusted to reduce the exposure to more manageable levels in order to reduce risks.

In the next article, I will touch on geographical exposure for the portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.