ETF investors should think about how to incorporate sector-specific investments to best position portfolios for today’s market.
On the recent webcast, Sector ETF Strategies to Manage Risk and Enhance Returns, Steve Deroian, Head of ETF Strategy at John Hancock Investments, and Peter Dillard, Chief Data Officer and Head of Investment Analytics and Data for Dimensional Fund Advisors, looked to how sector investing has evolved and ways investors can incorporate sector-specific ETF strategies in a diversified investment portfolio.
The sector landscape experienced a seismic shift after the Global Industry Classification created the newly dubbed Communications Services sector by combining stocks from Technology, Consumer Discretionary and Telecommunications. FTSE Russell later followed up by carving out the REITs sector and expanding the Telecom sector to include the media industry. More recently, ICE Data Services created the Media and Communications sector and reclassified some stocks within other sectors.
Consequently, investors are now exposed to a new communications sector that incorporates many traditional telecommunication services components like AT&T and Verizon, along with entertainment and media companies taken out from the technology and consumer discretionary sectors, including prominent names like Alphabet’s Google, Facebook, Comcast, Disney and Netflix, among others.
Investors who are interested in sector-specific plays may also want to pick their battles. John Hancock believes that investors should take a barbell approach with two sectors for offense and two for defense. Specifically, they advised investors to consider a position with a moderately pro-growth stance, emphasizing high-quality cyclical exposure, balanced by some defensiveness. For example, investors may look to technology and healthcare sectors for above-average betas for upside capture. On the other hand, the consumer staples and utilities sectors offer defensive characteristics for downside management.
Investors can also focus on market sectors through ETFs to take a more targeted approach with their portfolios, including the:
- John Hancock Multifactor Consumer Discretionary ETF (NYSEArca: JHMC),
- John Hancock Multifactor Financials ETF (NYSEArca: JHMF)
- John Hancock Multifactor Healthcare ETF (NYSEArca: JHMH)
- John Hancock Multifactor Technology ETF (NYSEArca: JHMT)
- John Hancock Multifactor Consumer Staples ETF (NYSEArca: JHMS)
- John Hancock Multifactor Energy ETF (NYSEArca: JHME),
- John Hancock Multifactor Industrials ETF (NYSEArca: JHMI)
- John Hancock Multifactor Materials ETF (NYSEArca: JHMA)
- John Hancock Multifactor Utilities ETF (NYSEArca: JHMU)
- John Hancock Multifactor Media and Communications ETF (NYSEArca: JHCS).
The John Hancock sector ETFs are multi-factor, smart beta strategies and the underlying indices’ methodology are managed by Dimensional Fund advisors, a pioneer in applying insight from academic research to a systematic investment process that pursues higher expected returns through advanced portfolio design and implementation.
Dimensional’s approach to sector indexing directly targets factors associated with higher expected returns, provide broad diversification to increase the reliability of capturing sector beta relative to strategies that are concentrated or ignore market prices, and aim to limit turnover to trades that meaningfully affect expected returns.
Consequently, due to the indexing methodology, John Hancock sector ETF investors may find that they are not as overexposed to some of the largest companies within the given sectors. For example, the S&P 500 Information Technology Sector may hold over 30% toward Microsoft and Apple, but JHMT only includes a little over 10% allocated to the two tech names.
John Hancock Investments and Dimensional Fund Advisors outlined four major factors that help drive expected returns for their smart beta strategies, including the equity premium, small-cap premium, value premium and profitability premium.
Specifically, the market equity premium reflects the outperformance of stocks over bonds. The small-cap premium corresponds to the outperformance of small-caps over large-caps. The value premium relates to value stocks over growth stocks. Lastly, the profitability premium shows that highly profitable companies tend to do better than less profitable companies.
Academic and historical data have helped support the basis for targeting these types of premiums. A study conducted by University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French found that focusing on smaller stocks and those with lower relative prices may improve a portfolio’s expected return. Additionally, in a separate research paper, profitability is seen as another factor that enhances expected returns.
When combined, the various factors may help improve a portfolios risk-adjusted returns over time. The Dimensional Fund Advisors’ multi-factor strategies selects securities of a specific sector with a desired market capitalization range, with an increase emphasis on higher expected return securities. The securities will exhibit lower relative price, higher profitability and lower market capitalization. Moreover, securities’ weights are capped to diminish concentration.
Financial advisors who are interested in learning more about sector strategies can watch the webcast here on demand.