Diversification is a buzz word in investing, but not without good reason. There is sound theory behind it – investing across a range of companies and sectors can help lower the overall risk of your portfolio.
The ASX can be divided according to the Global Industry Classification Standard (GICS). The GICS consists of 11 sectors, which have been aggregated from 69 industries. Each of those 11 sectors has unique attributes and will respond differently throughout the economic cycle.
Here, we take a closer look at each ASX sector and how investing across sectors can help you build a diverse ASX portfolio.
The consumer discretionary sector is comprised of businesses that sell nonessential items. Things that people like to have, if they can afford them, but can go without without causing any major harm. Consumer discretionary covers a range of industries including retail, apparel, and restaurants.
Demand for consumer discretionary goods is fairly elastic, in that it will respond quickly to changes in spending power or the price of goods. For this reason demand for consumer discretionary products is seen as cyclical – it rises when the economy is performing well, and falls when the economy is faring badly. JB Hi-Fi Limited (ASX: JBH) and Kogan.com Limited (ASX: KGN) are 2 ASX shares operating in the consumer discretionary sector.
The consumer staples sector is made up of companies that sell everyday essentials, which are things like food, healthcare, and hygiene necessities that most people won't go without. Consumer staples covers food and drug retailing, tobacco and alcohol, and household products.
Demand for consumer staples is fairly inelastic so this sector is seen as counter cyclical – consumers will largely need to keep buying the products regardless of the economic conditions. Coles Group Ltd (ASX: COL) and Woolworths Group Ltd (ASX: WOW) operate in the consumer staples sector.
The energy sector is composed of companies engaged in the oil, gas, coal and consumable fuel industries. Companies will be involved in exploitation and production, refining and marketing, or storage and transportation of various fuel types.
The financials sector contains companies involved in banking and mortgage finance, specialised finance, consumer finance, asset management and custody, investment banking brokerage and insurance.
The financial sector has suffered over the past couple of years as the Royal Commission and low rate environment have taken their toll. Margin compression, remediation costs, profit and dividend cuts have been the order of the day. ASX shares operating in the financials sector include Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB), and Australia and New Zealand Banking Group (ASX: ANZ).
The healthcare sector includes healthcare providers and services, businesses that produce healthcare equipment and supplies, and health technology companies. It also includes pharmaceutical and biotechnology companies.
Healthcare share have traditionally performed well late in the economic cycle when share prices are peaking and then declining. In this way they can be seen as somewhat countercyclical. ASX-listed healthcare shares include CSL Limited (ASX: CSL), Ramsay Health Care Limited (ASX: RHC) and Cochlear Limited (ASX: COH).
The industrial sector includes manufacturers of capital goods, providers of commercial and professional services, and transportation providers. Capital goods includes building products, machinery, aerospace and defense, and construction and engineering services. Commercial and professional services includes environmental and facilities services, office, security, human resources, and consulting services.
The information technology sector is composed of companies that offer software and information technology services, and manufacturers and distributors of hardware. Technology sector shares have a tendency to outperform during early and mid stages of the economic cycle, when the economy is in recovery and prior to its peak.
The ASX has seen an increasing number of information technology shares list in recent years. There are now plans to create a mini-NASDAQ with the launch of the S&P/ASX All Technology Index next year. ASX technology sector shares include Xero Limited (ASX: XRO), Computershare Limited (ASX: CPU), and Altium Limited (ASX: ALU).
The materials sector includes resources and mining companies, businesses that manufacture construction materials, chemicals, glass and paper and packaging products. Companies in this sector can be sensitive to changes in the business cycle and perform better when the economy is firing. ASX-listed materials companies include BHP Group Ltd (ASX: BHP), Rio Tinto Limited (ASX: RIO), and Fortescue Metals Group Limited (ASX: FMG).
The real estate sector consists of companies involved in property development and operation as well as companies offering real estate related services and real estate investment trusts (REITs). ASX-listed securities in the real estate sector include Goodman Group (ASX: GMG), Scentre Group (ASX: SCG), and Mirvac Group (ASX: MGR).
The communications services sector covers companies that facilitate communication and offer related content and information through various mediums. It includes telecommunications and media and entertainment companies. ASX-listed companies in the communications services sector include Telstra Corporation Ltd (ASX: TLS), REA Group Limited (ASX: REA), TPG Telecom Ltd (ASX: TPM).
The utilities sector is comprised of utilities providers such as electricity and gas companies. It also includes power producers and traders, and renewable energy companies. Utilities companies listed on the ASX include AGL Energy Limited (ASX: AGL), AusNet Services Ltd (ASX: AST), and Spark Infrastructure Group (ASX: SKI).
Investing across the various sectors of the ASX is a good start to ensuring a well diversified portfolio. Some sectors will perform strongly when others perform poorly, and vice versa. Exposure can be fine-tuned by diversifying within sectors. Investment allocations will also be dependent on your investment goals and risk tolerances.