Sector Strategies Solutions

Sector tilt and sector rotation are examples of sector approaches. A sector tilt approach overweights or underweights the portfolio in relation to specific sectors, while a sector rotation approach moves the portfolio through sectors over time based on expectations for the economic cycle. Global and international approaches can represent another layer of tilt and rotation. Global strategies include U.S. sector exposures, while international strategies do not; both are often based on the same underlying rationale as their domestic counterparts.

Choosing the Right Sector Index
Sector strategies are implemented by buying and selling sector-based investment products. These products are based upon a variety of market indexes, and most of the major ones are broken into even smaller subcomponents called subsector indexes. With so many indexes, there are two main questions to ask:

“How does the index classify stocks?”

“How broad or deep is index coverage?”

Sector Classification - ICB vs GICS
Index providers follow one of two classification systems. Known as ICB (Industry Classification Benchmark) and GICS (Global Industry Classification Standard), these identify the stocks that belong to a named sector.

Source: Dow Jones (icbbenchmark.com) and Standard and Poors (http://www.standardandpoors.com/indices/gics/en/us)

Breadth and Depth
Sector indexes differ in their universe breadth and depth. Indexes with more members generally have fewer concentration issues, and therefore are more easily investable. Indexes with greater depth tend to have more comprehensive representation of smaller companies. In some sectors, like Healthcare, where innovation may occur in the smallest companies, having greater exposure to smaller capitalization companies may be desirable. In contrast, S&P 500 Sector Indexes offer exposure to predominantly large capitalization companies.

Source: Morningstar as of 9/29/11. Index constituents are subject to change.

Other methodology considerations, such as when initial public offerings (IPO) are included and how often the index is reconstituted, can also lead to meaningful differences in sector index exposures.

Sector Tilts
Investors can implement tilts by adding sector, or subsector, exposures to an existing portfolio. This approach is attractive because there are no requirements for the portfolio to change its current investment strategy. The sector investments “tilt” the portfolio by adjusting exposures to various sectors.

To determine tilt allocations, investors begin with their benchmark sector exposures or, if the fund is actively managed (meaning that the fund seeks to outperform a market benchmark), the manager exposures. Then, adjust as appropriate. Tilt percentages can be absolute percentages (5% of the portfolio) or relative to the benchmark or manager (+/- 50% of benchmark sector weight). Funding for tilt allocations can come from a specific asset class such as U.S. equities or cash, or be a percentage of the overall portfolio.

Sector Rotation
A sector rotation approach is often used by investors with a strong strategic view on where the economy is headed. With this approach, the portfolio’s equity allocation is typically all sector-related investments. As economic conditions change, the portfolio is “rotated”, into other sectors considered more likely to outperform. Sectors that are not expected to perform well are underweighted or eliminated from the portfolio. The portfolio is dynamically adjusted as the economic cycle progresses.

Since the equity portfolio is typically fully invested, funding for overweight positions may need to come from implementing underweight positions. In determining portfolio sector weights many investors start with the sector weights of their preferred market benchmark and then adjust these weights as appropriate. Similar to tilt approaches, target weights can be absolute percentages of the portfolio (15%) or benchmark relative weights (+/- 5% benchmark sector weight).

Example: Domestic Sector Approach
An investor, whose domestic equity performance is measured against the S&P 500 Index, believes the economy is headed towards contraction. He decides to implement a domestic sector approach. To manage benchmark risk, initial portfolio weights are set to S&P 500 sector weights. To position his portfolio defensively, he takes 5% overweights in Consumer Goods, Healthcare, and Utilities. Funding these positions are underweights in his three least favored sectors - Basic Materials, Consumer Services, and Industrials. The six other sectors remain at benchmark weights. As the economic cycle progresses, he monitors the portfolio for adjustments.

This information should not be relied upon as research, investment advice or a recommendation regarding any security in particular. This information is strictly for illustrative and educational purposes.

Global Sector Strategies
Overlays and rotation strategies can also have a global or international scope. The benefit is greater exposure and therefore the opportunity for a greater risk-adjusted return. For investors with a U.S. equity strategy already in place, international sector strategies are often more attractive given the lack of U.S. overlap when both strategies are considered together. For investors wishing to include U.S. exposure, global sector strategies may be more appropriate. The growth in non- U.S. based products has made global sector investing easier in terms of choices and access.

With a broad range of domestic, international and global sector products, iShares ETFs provide investors with the ability to implement their views with ongoing precision and modularity.