Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

A fresh approach to equity diversification

Henry Cobbe CFA, Investment Director at Elston Consulting, looks beyond regional equity diversification to consider sectors, factors and themes.

Trader Source: Bloomberg

The most traditional approach to world equity diversification is a regional approach. This gives investors the ability to overweight or underweight particular markets, on the outlook of their economies.

Whilst this is straightforward, cheap and aligned with fund sector classifications, it is restrictive and increasingly dated.

A lot of what drives share price performance is based on which sector they are in (Energy stocks are having a great time now, Consumer Discretionary less so), the factors that drive their returns (Value is currently outperforming growth), or long-term structural themes (like food production or cyber security).

Indeed many managers talk sectors, factors or themes, but invest by region. This doesn’t make much sense. So sector, factor and thematic exchange traded funds (ETFs) can help.

How do we differentiate between these categories?

Sectors group companies by their business activity. These industry classifications are long-standing and relatively stable enabling research as regards sector performance in different economic regimes.

Factors group equities with similar style characteristics. Factors are the broad persistent explainers of return explored in academia. Examples of factors include value (companies whose price is cheap relative to their fundamentals), size (small cap vs large cap), quality (higher return on equity (ROE) and gross margin), momentum (companies with rising share prices) and minimum volatility (less volatile share prices).

Themes group companies by exposure to a structural long-term theme that could act as a tailwind for growth. Examples of themes include food security, cyber security, medical cannabis & life sciences, to name a few.

By allocating according to sectors, factors, or themes, investors can capture investment style while minimizing idiosyncratic risk.

What are the options?

Sectors, Factors and Themes offer a more coherent grouping of companies than the region of their headquarters. This provides a more nuanced way to implement tactical views and a more targeted approach to equity diversification.

Notices

All ETFs mentioned are London-listed ETFs and available on the IG share dealing platform.

Your capital is at risk. The value of shares, ETFs and ETCs can fall as well as rise, which could mean getting back less than you originally put in.

The views and comments are the author’s own and do not constitute a personal recommendation, advice or marketing communication.

This is not an offer of, or solicitation for, a transaction in any financial instrument. Neither the author nor IG accept responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk.


This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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