Unintended Sector Weightings

David Rosenberg put out a report that focuses on why he believes commodities are in a secular bull market with many more years to run. I would suggest you read the report (.pdf - you will have to register if you have not done so already). I wanted to focus one narrow point that I think is a tie in with a point I have been making here for a long time.

Rosenberg believes that the commodity bull favors Canadian equities over US equities. The line of thinking is easy to follow. Canada is a commodity based economy and the stock market there has a heavier weighting to energy and materials companies.

The table to the right (click to enlarge) compares the sector weightings in the TSX versus the S&P 500. According to the table, energy accounts for 27% of the TSX. This is in the same ballpark as the iShares Canada Fund (EWC) which allocates 25%.

One issue that often comes up in portfolio construction is unintended sector weightings. With the transparency of ETFs (the context here is people that do not want to pick a lot of individual stocks), this issue simply becomes a spreadsheet problem.

Anyone investing at the sector level needs to make decisions about how much to have in each sector. If an investor, for whatever reason, decides they want to target 15% in energy and they build a portfolio combining sector, country and thematic funds, then they have to look under the hood and simply calculate how much energy exposure their various funds give them.

Let's look at a simplified example with the 15% in energy. A 10% portfolio weight to EWC creates a 2.5% portfolio weight to energy. A 10% weight to WisdomTree International Energy ETF (DKA) obviously adds 10% of energy to the portfolio but with no Canada -- so no unintended overlap. And the last 2.5% for the sector could go into a specialized fund like Market Vectors Coal (KOL). KOL is heaviest in the US at 46%, China 22%, Indonesia 16% and they get much smaller from there so again not much overlap with EWC or DKA.

To repeat, this was just an example. Obviously the above would require having positive opinions about Canada and coal and the desire to have most of the energy exposure in foreign. (DKA is a client holding.)

EWC has heavy weightings to financials at 36% and materials 17%. So obviously they would need to be taken into account with the building of those sectors with other funds. Materials are about a 3.5% weight in the S&P 500 so the 10% allocation to EWC gets the portfolio about halfway to an equal weight exposure.

Additionally, Morningstar Portfolio X-Ray can help with this.

Comments

[Vaun:]

love that tool

Sep 27 10:42 AM