For the best part of a year now the FTSE has gone nowhere. The battle between the bulls and the bears has kept our favourite index range-bound around 6,000.
And while I reckon there’s more downside risk to the Footsie than upside opportunity, that doesn’t mean there aren’t any great profit opportunities out there.
Individual stocks can do very nicely regardless of the general economic environment (though stock picking can be a risky affair). But there’s another approach that I think could produce serious returns in the months ahead – sector investing.
Why buy the whole market when you can just buy the sectors you like? And if you’ve got the stomach for it, why not short the rotten sectors too?
As I see it, there are three great reasons to adopt sector investing right now.
1. You can easily spot winning themes
Stocks within a sector tend to move in concert. They can be driven up as mergers and acquisitions take hold of the sector – which can gather pace as everyone wants to get in on the action.
Or it could be technology that drives events – the internet boom being an obvious example.
Or it could be as simple as demographics and increasing general demand. You could be looking at global energy and resources as a play on global demographics.
Right now, I’m still keen on the energy sector. My personal pension fund is certainly set up to profit from global demand for resources that I see continuing over the next twenty years or so.
2. You can reduce volatility
I like the idea of picking winning stocks, but we all know it can be dangerous.
We need look no further than BP to see exactly how dangerous. Last year, the Deepwater Horizon oil spill savaged many pension funds (I wasn’t left unscathed myself). Not only were capital values hit as the shares tanked, but it played havoc with funds’ dividend streams.
That’s why a play on the sector can be a much safer bet. That way you can even out the inevitable volatility from individual stocks.
In reality, I still like BP and I still like individual stocks. But at least half of my portfolio is held in investment trusts, exchange traded funds (ETFs) and spread bets that benefit from broad sector moves.
3. You can enhance predictability
Markets are fuelled by psychological factors – specifically fear and greed. Herd instinct must never be ignored. It constantly shows up in broad sector moves.
With a sector you’re betting on the average price of a basket of stocks. You don’t need a degree in statistics to know that averages move in much more predictable ways.
Whether you’re inclined to invest using contrarian strategies, ie betting against the herd, or you prefer momentum investing (following the herd); the sector approach can give you a massive advantage.
It allows you to stand back and better discern the wood from the trees.
My favourite sector trade right now
You may know by now that I like investment trusts. And there are many sector specific investment trusts available. If you want to find one, then go to the Association of Investment Companies website and search by sector.
For instance I like the Worldwide Healthcare Trust PLC (LSE:WWH) which I tipped at the beginning of the year at £6.97. It focuses on global pharmaceutical and healthcare stocks. As I said at the time, I think big pharmaceuticals offer the best kind of insurance for your portfolio right now. They produce goods which are essential to modern life and they throw off plenty of cash.
The sector has been out of favour for some time – despite some very exciting developments in biotech and drug development.
WWH is now trading at £7.60 – that’s up about 9%. Not bad given how global markets have been in the meantime. You can read my full investment case for WWH here.
As well as investment trusts, you can buy ETFs that home in on specific sectors like water, energy, industrial materials and communications, to name but a few.
Sector specific investment trusts and ETFs tend to take a global approach. They invest in the world’s largest players in the specific industry. And that’s great if you’re looking to reduce volatility. You’re getting globally diversified exposure and you’ll be doing so without having to pay the earth in management fees.
But if you want to play specific UK sectors, then you’ll need to use a spread-bet, or contract for difference.
Recently we’ve used sector spread bets to short UK banks and to go long UK industrial engineers.
Both these bets (or should I say investments?) have been doing pretty well. And later in the week I’ll give you an update on the trades and tell you what I think we should do now. I think it’s worth dedicating an issue of The Right Side to it.
In the meantime, why not think about some sectors you like. Have a look at The Association of Investment Companies website for some ideas on global sector investments.
And if you haven’t got a spread-bet account, take a look at MoneyWeek’s comparison table. Just remember that spread bets should be treated with great care. With a leveraged spread bet, you can lose more money than you put in.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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Worldwide Healthcare Trust five year performance: 2006 -14.15% | 2007 +2.11% | 2008 +12.96% | 2009 +10% | 2010 +13.96% | 2011 +8.98%
Spread betting is not suitable for everyone – ensure you fully understand the risks involved and never risk more than you can afford to lose. Spread betting carries a high level of risk to your capital. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Margin amounts vary between spread betting companies and the type of markets spread bet.