by Alex Holmes
The bull market has continued to edge higher in 2021 with stimulus package discussions continuing in the U.S., global vaccine rollouts – and even Jack Ma making public appearances again! There has been significant outperformance in certain sectors, notably mega-cap Tech, and other sectors such as Energy and Financials, which have generally underperformed since the market rally started in 2020.
The question on many investors’ minds is whether 2020’s hot sectors can continue their momentum in 2021, or the sector rotation of late last year will pick up steam. Interestingly the price growth gap between S&P 500 Growth and S&P 500 Value is as wide as it was in December 1999 before the dotcom crash1.
Are there strategies an investor can take advantage of when certain sector valuations come into question?
Below we outline three potential portfolio strategies to stay invested and help position your portfolios in 2021.
1. Tactical exposures to value-tilted sectors – Energy and Financials
Two sectors that have not kept up with Tech’s outperformance over the last year are Energy and Financials, as illustrated in the above chart. Energy is down -30.8% and Financials -2.7% on a one-year basis.
Before the COVID-19 pandemic both sectors had been under pressure from innovation and disruption, particularly with the rapid rise of EV vehicles and fintech disruptors in financial services. Both sectors were hit hard in the pullback last year; however, as the world economy began to reopen, these sectors showed some short-term outperformance in late 2020. In December 2020, Financials rose +5.2% and Energy +4.3%. Additionally, the global outlook for banks has seen a number of positive trends emerging, including what could be a plethora of M&A deals in 2021.
Investors can consider the tactical use of sector ETFs to position their portfolios for a potential continued recovery in these sectors. Investors looking to increase exposure to global banks may wish to consider the BetaShares Global Banks ETF – Currency Hedged (ASX: BNKS), or exposure to global energy companies via the BetaShares Global Energy Companies ETF – Currency Hedged (ASX: FUEL).
2. Barbell strategies – complimenting growth exposures with value exposures
A barbell strategy is an investment strategy that seeks to strike a balance between risk and reward by investing in two ‘extremes’ while avoiding middle of the road choices. The current high concentration in some sectors of the market provides an interesting opportunity to implement this strategy.
An easy way to understand the barbell strategy is in Fixed Income, where the strategy might consist of being invested in long-term bonds at one end of the ‘barbell’, and holding short maturity fixed income investments at the other end, to take advantage of the different benefits the two types of investment can offer.
An example of a barbell strategy in an equity portfolio is a blend of equities with high betas concentrated in a certain sector, with a component invested in low beta, more defensive stocks.
For example, the global technology sector has performed very well in recent years, and particularly during the COVID-19 pandemic. However, if an investor is of the view that Technology (U.S. tech in particular) is expensive at the moment, one approach could be to put new equity allocations into more value-orientated exposures, such as Energy and/or Financials.
3. Equal weight exposures – S&P 500 Equal Weight
Another way to gain exposure to unloved, or what may be perceived as undervalued, sectors is through an equal weight strategy.
An equal weight exposure can provide your portfolio with increased sector and size (away from mega caps) diversification compared to a market capitalisation approach, particularly in an environment where concentration in broad indices is extremely high, driven by momentum in growth stocks. As the chart below illustrates, the top five stocks in the market cap-weighted S&P 500 Index now represent close to 25% of the index, a level not seen since the 1970s.
The cumulative weight of the largest five S&P 500 companies hit multi-decade highs recently
The S&P 500 Equal Weight Index equally weights the S&P 500 constituents at each quarterly index rebalance (each company represents 0.2%) and provides an alternative to a market capitalisation approach in the U.S. Investors can gain exposure to this index via the BetaShares S&P 500 Equal Weight ETF (ASX: QUS), which aims to track the performance of this index before fees and expenses.
Benefits of an equal weight strategy include:
- increased diversification and lower stock concentration compared to a market capitalisation approach
- potential benefits from mean reversion
- exposure to smaller stocks without having to invest directly in less-liquid small-cap companies.
QUS potentially can be considered as part of a barbell approach in your equity portfolio. By way of illustration, a 50/50 blended exposure to the Nasdaq 100 Index (NDX) and the S&P 500 Equal Weight Index (SPW) historically has shown a ‘smoother’ trend of outperformance versus the market-cap weighted S&P 500 Index (SPX) over the 26-year period to December 2020. Of course, it’s important to remember that past performance isn’t indicative of future performance of any index or ETF, and you cannot invest directly in an index.
The Nasdaq 100 + S&P 500 Equal Weight Barbell Example – as at 31/12/2020 (total return)
A barbell strategy comprising a 50/50 blend of the two indices mentioned above could provide exposure to both momentum and mean reversion in your international equity allocation, which in a period of increased sector concentration may be one way to stay invested and tap into areas of growth.
Given the strong performance of equity markets in general and the global tech sector in particular over recent months, investors may be re-assessing their exposure to the sharemarket. Investors looking to diversify their share allocation, or to decrease exposure to 2020’s ‘hot’ market sectors, could (depending on their views and personal circumstances) consider a number of strategies, including increasing their exposure to ‘unloved’ sectors such as Energy and Financials, adopting a barbell strategy or taking an equal-weighted approach to their U.S. equities allocation.
Investing involves risk. The value of an investment and income distributions can go down as well as up. Before making an investment decision you should consider the relevant Product Disclosure Statement (available at www.betashares.com.au) and your particular circumstances, including your tolerance for risk, and obtain financial advice. An investment in any BetaShares Fund should only be considered as a component of a broader portfolio.
1. Source: Bloomberg SGX vs SVX. As at 31 January 2021.