Unpacking Global Sectors

Recently, many have reasoned that sectors drive market returns. Using the complete lineup of global sector ETFs from iShares, an investor can utilize the power of sectors within the US while reaching into developed and emerging international markets for simple to complex asset allocation strategies.

By breaking down the global sector ETF products on the market, the investor can get a grasp of the best way to capture sector returns throughout the globe, in domestic, developed and emerging markets.

Businesses throughout the globe seem to correlate most with other companies within sector groups even before country, region, size and style.  Therefore, when using a strategy involving sectors, reaching outside the US, even into emerging markets, makes sense as a way to add better risk and reward possibilities while controlling sector exposure, which tends to be correlated even across regions and borders.

Global returns can be explained by sector returns. Correlations among countries can even be explained in a great deal by sectors and the differences in asset allocations between their respective market indexes.

The Global Benchmark

The 10 global sector iShares ETFs represent the sector makeup of the S&P Global 1200, which represents 70% of the world’s market cap. The sectors are broken down from this index based on the 10 GICS (Global Industry Classification Standard) sectors, which are jointly managed by S&P and MSCI Barra. Below is a chart of the iShares global sector ETFs. Each ETF represents a GICS sector from the S&P Global 1200 Index. Also included are each ETF’s total net assets.

Global 1

The GICS sectors are designed to place companies throughout the globe into sector categories.  Currently, the S&P Global 1200 Index, which is made up of the 10 GICS sectors, is broken down below as of 9/30/2009.

Global 2

Data: Morningstar Office 9/30/2009

Why Global

Since sectors have a higher correlation globally compared to different sectors domestically, investing on a global sector basis could provide significant risk reward profiles, as making sector decisions for the US is benefited by global correlations and the higher growth possibilities abroad and the lower correlations to the overall US market. Instead of concentration on sectors domestically and adding international exposure, moving to a global sector strategy is a way to capture both domestic and international exposure. Since sectors seem to correlate throughout the globe, from US companies to companies within emerging markets, using global sector ETFs is a way to efficiently execute an investment strategy involving sectors.

global 3

Data: Morningstar Office 10/1/2004-9/30/2009 (US sectors are the S&P 500 GICS Sectors and Global Sectors are the GICS Sectors from the S&P Global 1200 Index.)

The above scatter plot displays the similar risk and total return characteristics of the US sectors, shown as circles, and the global sectors, shown as squares of similar colors. Note that the global sectors do include a significant allocation of US holdings and the chart merely shows the movements of a sector as international developed and emerging markets are added. In general, the movement from US to global has a positive risk reward effect.

Comparing global sectors to the S&P 500 GICS Sectors shows the benefit that could be added to US sectors by adding international holdings. The differences vary throughout the different sectors; however, typically, the global sectors (squares) are above and often to the left, showing higher total return and less risk throughout the last five years. This is what using global sectors would have added even if the investment decision was based on the more familiar US sector analysis. Based on the above chart, over the past five years, adding international sector holdings to US sectors had a positive effect.

Reaching Out Internationally

The Global Sector ETFs, being market cap weighted, have heavy US allocations. This provides a way for the investor to make global sector allocation decisions while leaving domestic and international, developed and emerging market and market cap decisions to the index or marketplace since correlations among sectors run high across borders.

This means that the risk of adding international sectors to sector strategy decisions has a low marginal affect on risk relative to the overall sector decision. This is because correlations have been proven to be high within sectors, explaining returns. Therefore, the largest risk factor is in the sector and the risks associated with it.  Emerging and developed international markets will bring unique risks; however, the risks of the sector are among the most dominant.

The graph below breaks down the exposures of US, international developed and emerging market  holdings within the iShares ETF series. It is interesting to note that the breakdown of developed versus emerging markets shows the areas where emerging markets have the greatest effect on the global economy. For example, the iShares S&P Global Materials Sector Index Fund (NYSE Arca: MXI) has an 8.5% exposure to emerging markets, which shows the growth of the world’s demand of developing countries’ mining products, metals and other materials.

global 4

Data: Morningstar Office 10/6/2009

Sectors Have A Place

Keep in mind that this is not necessarily a call to abandon broad diversification, but a need to focus on the importance of sectors as they relate to global return. Also, when investing with sectors, using and adding international exposure has returned benefits to almost every sector. In this way, an investor can analyze and invest among US sectors, while gaining correlated international exposure, which has higher long term risk and reward potential.

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