Abstract
Sector allocations are among the most important portfolio decisions one can make. Not only are they one of the primary drivers of total return, they can prove to be important portfolio diversifiers as certain sectors tend to zig when the market zags. The high volatility of sector investments, however, can make sector investing a risky proposition. The spectacular crashes in the Technology sector in 2000 and the Financial sector in 2007-2008 illustrate that it is often times more important to avoid overexposure to the wrong sectors than it is to try and pick the best ones. An evenly-weighted sector portfolio-a portfolio that has exposure to each market sector in equal proportions-can unlock the return potential of sectors while simultaneously minimizing overall portfolio risk. Maintaining equal exposure to every market sector ensures some level of participation in a sector-led rally without the risks of making an individual sector bet. Periodic rebalancing back to equal sector weights also minimizes the negative impacts of a sector bubble. In essence, an equal sector portfolio ensures enough exposure to every market sector while limiting too much exposure to any one sector. An equal sector portfolio also has the advantage of maintaining very similar characteristics to its underlying benchmark index. Other index approaches that are based on equal stock weights or individual factors such as P/B, P/CF or dividend yield can create significant size or style biases. An equal sector portfolio's ability to minimize risk and tracking error relative to its benchmark makes it a suitable alternative to both actively managed and fundamental index approaches.
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