The Bottom Line
- Looking at sector returns within the S&P 500 Index provides a good illustration of a potential advantage that active strategies can have over passive ones.
- As the chart shows, sector1 performance varies, often significantly—and rebounds from downturns can be powerful.
- That means active managers with the ability to overweight, underweight or even avoid certain sectors altogether have the potential to produce results that can differ from the underlying index to which passive strategies are tied.
- Yet successful active managers don’t simply make guesses about the future direction of sectors based on recent absolute and relative performance.
- Instead, when a sector comes under pressure (like Energy, Materials and Utilities in 2015) they may view it as fertile ground to look for new opportunities—or add to existing ones—in individual company stocks where significant gaps may have emerged between the current security price and what they think the business is really worth.
- Conversely, price-value discrepancies can also arise in the other direction. If a sector has shown strong performance active managers may consider it an opportunity to scrutinize the valuations of holdings in that sector and consider reducing exposure.
- Of course mispriced securities can also occur in sectors with just average recent performance, but big swings in either direction—especially in a relatively short period of time—often create more pronounced opportunities.
1 The S&P 500 is actually composed of 11 main sectors now. There are 10 sectors shown in the chart: Consumer Discretionary, Consumer Staples, Energy, Financials, Healthcare, Industrials, Information Technology, Materials, Telecommunications and Utilities. Recently REITS were added as the 11th sector, which is not represented in the chart.