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Company reporting season is a good time for investors to look at their portfolios. The latest update from companies you own is important information, and could lead to adding to existing holdings or selling out of a company’s shares. In considering where to place any uninvested funds, investors may look to the sectors of the market for guidance.

Most share markets are now divided into sectors by the Global Industry Classification Standard (GICS).  These categories were devised by index providers to help global investors better understand non-domestic share markets. There are ten sectors, further divided into sub-sectors.

Source: Wikipedia

This “one-size fits all approach” can lead to some interesting local quirks. For example, data and records storage group Iron Mountain falls under Financials– specifically, it is classified as a specialised real-estate investment trust.

Diversification is a time-honoured risk management tool. To gain full benefits, investors are usually diversified across asset classes – shares, property, fixed income, collectibles, cash etc – and within those asset classes. Analysis at CMC shows Australian direct shareholders diversified over the previous twelve months. However, portfolios remain narrowly focussed, with an average of only eleven stocks per account. The risk is elevated where there a number of stocks from the same industry.

Having a narrow portfolio can be a deliberate strategy, taking higher risks to generate potentially higher returns. But for investors uncomfortable with the swings in their portfolio’s value, spreading across sectors can steady the performance. Here’s the current weightings for each sector in the Australia 200 index:

Source: Bloomberg

Ever watched the market roar while your portfolio whimpers? The most likely reason is that your portfolio doesn’t match the index. It doesn’t have to – but differences can mean that hedging strategies using index based options or CFDs won’t track as well. They’re still useful investment tools, but there is potential for some slippage due to tracking error.

Clearly, there are many good reasons for investors to tilt their portfolio way from the index, especially in the name of outperformance. But an awareness of the sectors, and how an individual’s holdings compare to the index, can lead to more informed decisions.

Which sectors should investors examine closely? The answer will depend on the individual, and their circumstances. There is no single right answer to the question, but a good place to start is in sectors where an investor has little or no exposure.

Regular viewers of the Switzer report will know that I’ve mentioned the energy sector on a number of occasions over the past few months. The long term chart of the Energy sector index shows why it’s on my radar. This chart goes back to 1998, and each of the bars on the chart represents a month of trading.

At around 8,000, the index is trading at just 40% of its highest point, back at levels last seen in 2004. There are good reasons for this, not least the plunge in oil prices that saw West Texas light crude oil trade down to $26 a barrel.

Since the lows in Q1 this year the oil price has climbed and stabilised. My view is oil will trade a $40 to $50 range for the rest of the year. In other words, the cyclical down swing is over. While oil is unlikely to power higher anytime soon, the discount attached to energy stock prices is gradually being removed, which leads me to the conclusion that it’s time to add energy stocks to my portfolio.

Naturally, there are a variety of views around the best stocks to choose. Some investors prefer Santos under a new CEO, but the announcement this week of a further US $1.05 billion write down may deter. My preference is for the global gas plays, larger due to a view that gas is the answer in a carbon constrained universe. Woodside and Oilsearch are top of my list.

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