The traditional asset classes for retail investments
are stocks, bonds, and cash equivalents or money
market funds. For the past 10 years a growing
sector of smaller investors have been able to trade
in currencies and commodities as well. Today you
have the option to invest in a wide variety of asset
sectors.
As we discuss these equities and investment tools,
let’s begin with the grandfather of them all, stocks.
Stocks form the root of many indices, mutual funds,
and ETF’s. As you understand the fundamentals of
stocks and companies you can enter into trades
with both individual companies and funds with
greater confidence. It’s important to understand
these differences as they inuence risk and come
with historically different rates of return.
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Asset sectors often move in different cycles. When
you know what drives each cycle, you can better
understand how they fit within the trends. Learn
when they are in demand and when they may fall
out of favour. Discover typical risks and rewards.
Most investors use a sector breakdown of assets
to balance their portfolio. These nine sectors offer
a wide range of diversity within the stock market.
This information will help you understand each
sector and how it trends. Because we talk about
the market cycle throughout this chapter, here is
the chart to remind you of the cycle.
1. Consumer Discretionary: These are companies
that produce goods and services considered
nice to have, but not essential. People buy these
products with ‘extra’ money. When the economy is
good, people are more likely to spend money on
‘frivolous’ things, so consumer discretionary rises
as the economy improves and ourishes in bull
markets.
When the economy tightens, people cut back on
the extras, so this class trends downward in a
recession. Within this asset class, however, some
stocks may trend differently. Cheap entertainment,
like movies, tend to rise in bad times.
Some companies in this sector include:
Bertelsmann (mass media)
Amazon (consumer goods)
Christian Dior (luxury goods)
Walt Disney Co. (entertainment)
McDonald’s (fast food)
L’Oréal (cosmetics)
NIKE (clothing)
Time Warner (movies and entertainment)
2. Consumer Staples: These assets are
considered essentials. People do not stop buying
these products even in a recession. This sector
8.1 Asset Sectors
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includes agriculture, food, beverage, tobacco,
and pharmaceutical distributors. It includes non-
durable household goods and personal products,
including grocery stores and supercenters.
Late in the cycle as economies enter a recession
and during the recession, investors often move
into consumer staples and prices rise. They believe
assets keep their value better and are less likely
to uctuate in this sector. When times improve,
money rotates out of this sector to faster moving
assets and prices may dip. Overall, cycles tend to
be more muted in consumer staples and they are
often considered one of the safest and most risk
free sectors.
Stocks in the consumer staples sector include
companies such as:
Anheuser-Busch (beverages)
Walmart (retail)
Procter & Gamble Co (retail)
Sligro Food Group (grocery)
Coca-Cola Co. (beverage)
Philip Morris International (tobacco)
Carrefour (retail)
Unilever (personal care)
Nestlé (consumer goods)
3. Energy: This category includes stocks related
to producing or supplying energy. Traditionally,
the energy sector has been dominated by oil and
gas companies. Within the oil and gas industries,
companies are broken down into three types,
extraction (upstream), refining (midstream),
and distribution (downstream) of gas and oil.
Companies that engage in all aspects of energy
production are called integrated companies.
Integrated companies are less vulnerable to the
change in the price of oil or gas because the cost
of refining and transport may stay steady, when
the cost of extraction rises or falls.
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Upstream companies in exploration and extraction
expand when energy is in demand and suffer when
the price of energy drops. Because they are often
heavily indebted, these companies often do not
survive during down trends. They are more volatile
and carry more risk. Downstream distribution
companies may offer steady dividends in good
times and bad.
Coal, nuclear power, and renewable energy such
as water, wind, and solar are also included in the
energy sector. Historically, renewable energy stocks
were considered more speculative and carried
more risk. As technology improves and renewable
energy moves into the mainstream, the stocks are
becoming more stable. These stocks can uctuate
based on government policies and rebates.
Which type of energy stocks are affected most
when oil makes wild swings? When oil drops,
drilling stocks like Apache Corp and Marathon Oil
take a hit as do alternative energy stocks. When oil
surges, they rise with the tide. But it also carries
wind, solar, and electric vehicle stocks along with it.
Energy stocks include companies such as:
Royal Dutch Shell (oil and gas)
BP (oil and gas)
Nordex AG (wind power)
Yingli Green Energy Holding Co Ltd (solar)
Canadian Solar Inc. (solar)
ExxonMobil (oil and gas)
4. Financials: The financial sector covers financial
services to both retail and commercial customers.
This includes banks, insurance companies, thrift
and savings plans, investment managers, mortgage
companies, and real estate.
Financials tend to do well at the beginning of a
recovery as credit begins to grow. They prosper
in bull markets. In a recession, credit dries up and
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financials may see prices drop.
Real Estate Investment Trusts (REITs) follows a
somewhat different cycle. They may be more
dependent on interest rates. While insurance
companies are often considered steady,
dependable income in all market types. All financials
are sensitive to changes in laws and regulations.
Rising interest rates serve banks well, while falling
interest rates reduce their bottom line.
Financial stocks include companies such as:
ING (banking)
BNP Paribas (banking)
Allianz (insurance, annuities)
HSBC (banking and wealth management)
Munich Re (insurance)
Morningstar (investment)
Exor (investment)
5. Healthcare: Healthcare stocks deal with
medical goods and services. This includes
hospital management firms, medical equipment,
and medical products. It also includes research,
development, production, and marketing of
medical equipment, pharmaceuticals, and new
biotechnology.
All of these are considered essential so the
healthcare sector typically performs well in all
markets - bull or bear. However, it is subject to
swings based on politics and government policies,
subsidies, laws, etc. Pharmaceuticals and biotech
stocks may rise or fall based on new product
testing successes or failures or new competition to
existing drugs. Early stage biotechs are considered
highly speculative.
Companies in the healthcare sector include:
Bayer (pharmaceuticals)
Hoffmann-La Roche (pharmaceuticals)
GlaxoSmithKline plc (pharmaceuticals)
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Fresenius (medical equipment)
Capio Group (hospital management)
Kaiser Permanente (HMO)
6. Industrials: Industrial goods are companies
engaged in producing items used in manufacturing
and construction. Sub-sectors encompass
aerospace, industrial machinery, military
and defence equipment. It includes cement,
metal fabrication, pre-fab houses, and waste
management. The Industrial sector also covers
transportation companies such as airlines, trucking,
roads and railroads.
Look to essential products like rail and defence
to stay steady regardless of market trends. Huge,
diversified industrials, such as General Electric,
have offered good returns for years in all kinds of
market swings. However, housing construction and
industrial machinery generally slow in a recession.
Many analysts look to the trucking and
transportation sub-sector as a bellwether, as those
numbers tend to drop or rise ahead of a change
in trend in the larger market. In this sector, it pays
to look at specific trends within the broader sector
as you choose your assets.
Companies in this sector include:
International Airline Group (transportation)
LafargeHolcim (building materials)
Leonardo (aeronautics and defence)
CRH (building materials)
BAE Systems (aeronautics and defence)
Schneider Electric SE (automation/equipment)
Continental AG (automotive manufacturing)
BMW (automotive)
TUI Travel (transport)
7. Materials: Companies in this sector manufacture
or process chemicals and plastics. They mine or
extract minerals and metals. Paper, containers, and
packaging are part of this sector. Some analysts
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include forestry and construction in this sector
since they are closely aligned with packaging and
are the raw material for many products.
Chemicals are used across a broad range of
businesses so that they may hold up better under
a range of cycles. However, in a downturn, the
demand for them is reduced. Manufacturers use
gold and other metals which affect asset prices.
But precious metals also cycle with investor
demand for a safe haven. Investors may turn to
precious metals in times of economic and political
uncertainty and tend to reduce their holdings as
interest rates rise.
Companies in this sector include:
BASF (chemicals)
ArcelorMittal (steel)
Rio Tinto Group (mining)
LyondellBasell (chemicals)
Dow Chemical Co. (chemicals)
Rockwell Automation Inc. (automation)
Silver Wheaton Corp. (metals)
8. Technology: This sector includes IT businesses
and companies that research, develop, produce,
and distribute communication equipment such as
cell phones, towers, cable, etc. It includes computer
hardware and software, home entertainment,
office equipment, data management, processing
systems, and consulting services.
Because technology is constantly evolving, new
products can quickly become outdated. New
inventions can drive up stock prices, sometimes
dramatically. However, competition on price
and better inventions put downward pressure
on companies. These stocks usually have higher
volatility and risk. They typically do well in a rising
market and less well as markets shrink and
customers cut back.
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Many of these stocks have higher valuations
because investors expect more and better
products in the future. If their earnings statements
fall short of expectations, the price typically takes
a hit. Some traders use these volatility swings to
trade options or CFDs.
Some companies in this sector include:
Apple (communications)
Microsoft (IT)
Materialise (3-D printing)
Skype (communication)
Spotify (music streaming)
Shazam (tag songs)
Huddle (business software)
Blossom IO Inc. (product management tools)
Nginx (webserver)
9. Utilities: This sector distributes electricity, oil,
gas, water, etc. Utilities that distribute energy have
been considered ultra-safe stocks. Everyone needs
energy in good times and bad. They have been
used as income stocks to provide steady dividends
for retirees. Utility stocks tend to rise in recessions
as they are used as a safe haven. They may trend
down in good times as investors shift to more
profitable stocks.
Companies in the utility sector include:
Engie SA (electric utility)
E.ON ( electric utility)
Kenon Holdings Ltd. (power generation)
Artesian Resources Corporation (water)
Azure Power Global Ltd. (solar power)
You can see that diversifying your portfolio over
these sectors will give you stocks that rise in each
phase of the market cycle. And some, like precious
metals, that march to a different cycle altogether.
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Even within sectors, stocks are grouped based on
size, production, dividends, and location. Each of
these can bring investors added diversity. They
also help investors assess risk and likelihood of
growth or profit.
Size: Stocks can be grouped by the size of the
company. Often this is called a market cap, short
for market capitalization. Market cap is found by
multiplying the number of outstanding shares of
stock by the stock price. Companies are divided
into categories of small, medium, and large based
on that number.
There are no rigid or official numbers for the
groupings. Morningstar divides them by a
percentage. For example, the top 5% of stocks in
its database are labeled large cap. For investors
wanting to evaluate this aspect of their companies,
a dollar range may be more useful. Here are
generally accepted definitions.
Mega Cap: $200 billion or more
Large Cap: Between $10 and 200 billion
Mid Cap: Between $2 and $10 billion
Small Cap: Between $300 million and $2 billion
Micro Cap: Between $50 and $300 million
Nano Cap: Below $50 million
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Traditional investors believe large cap stocks have
the capital and depth to weather storms and
consider them a safer risk. Smaller cap stocks
offer more growth potential and have historically
outperformed the large cap stocks. For example,
the Wilshire Small Cap Value Index gained 371%
between 1999 and 2013 while the S&P 500 gained
only 97%. That’s a difference of 10.9% per year vs.
4.6% per year.
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But that increase came with volatility. Several of the
years showed marked losses for the small caps.
And if you go back to the 1984-1998 time frame,
8.2 Finding Diversity in Stocks
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Berger, Rob. ‘Large Cap vs. Small Cap Mutual Funds’ DoughRoller 14 June 2017
36
Carlson, Ben ‘The Small Cap Value Cycle’, A Wealth of Common Sense 8 Apr 2014
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the S&P outperformed the small caps by 4% per
year on average. Large and small caps cycle with
one performing better in certain timeframes.
Some investors keep large caps for their stability
and steady returns and add in some small caps for
growth.
Growth: Companies are also divided into growth or
income categories. Nearly every small cap has the
goal to grow into a large cap. Small caps often take
their profits and use them to grow their company.
They may acquire smaller companies, plough back
earnings into more resources to increase output, or
seek to expand their range of products they offer.
In these cases, investors don’t see payments in the
form of dividends. Rather, they look for returns in
the form of higher stock prices.
Income stocks, on the other hand, use less of
their profits for growth, and return more of it to
shareholders. Some companies return almost all of
their profits to shareholders. Investors don’t expect
these income stocks to increase in price as rapidly
as the growth stocks… or even increase much at
all. The security comes from having physical cash-
in-hand in the form of dividends that will be there
regardless of stock market swings.
Reinvesting these dividends back into stock shares
is one way to compound your interest and grow
value. While past performance is no guarantee of
future results, historically, reinvesting dividends
has produced steady gains in a portfolio.
Not every small cap is a growth company and not
every large cap is an income company. A check
of historical prices and the history of dividend
payments will help you recognise the kind of
company you are dealing with.
Dividends: Stocks are divided into dividend and
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non-dividend paying companies. As mentioned
before, those who do not pay dividends may be
reinvesting profits to grow. Many investors prefer
dividend paying companies because the dividends
are in-the-hand, not paper profits. They can also
be an indicator of the health of the company.
Rising dividends speak to the growth and health
of a company. Many investors look for this
track record of constantly increasing dividends.
During a downturn in the economy, some cyclical
companies may be forced to cut their dividends. If
a company makes poor decisions, they may have
to cut dividends. When companies cut dividends,
their share prices tend to drop.
Here is six reasons dividends matter.
1. Dividends reveal fundamentals. When a
company can pay steady dividends, it says
something about the stability and fundamental
value of the company. It’s possible for companies
to be creative with the books, so dividends
demonstrate cash profits. Companies MUST
have the cash to pay out dividends. However, a
high dividend in a company with low free cash
ow can also signal a problem. It may mean it’s
taking money from past, not current earnings, to
pay a dividend. This is not sustainable.
2. Dividends force companies to manage
better. A drop in dividends is seen as a failure
of management and usually brings lower
stock prices. Managers of dividend paying
companies have an additional incentive to be
wise. Studies show dividend paying companies
pay less for acquisitions than those who do
not pay dividends.
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So they are more efficient
for stockholders. The managers begin the year
deciding how much dividend they will pay out.
Then they look for the most efficient way to use
the rest of the free cash ow.
3. Dividends reduce market risk. When you have
cash in your account from dividends, it stays
there, whether the market goes up or down.
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Investopedia Staff, ‘Why Dividends Matter’, Investopedia http://www.investopedia.com/articles/fundamental/03/102903.asp
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Over a period of time, your stock may pay you
in dividends what it cost you initially to buy the
stock. For example, a stock with a 10% dividend
will pay for itself in 10 years.
4. Holds up better in bear markets. Dividend
paying stocks outperform in sluggish and in
bear markets. They don’t go down as much in
value and they tend to be less volatile. In a slow
market, a larger percentage of the total returns
come from dividends.
5. Outperforms non-dividend paying stocks. In
the long run and on average, dividend paying
stocks produce better gains than other kinds of
stocks.
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The longer you hold dividend paying
stocks, the better your returns tend to be.
Typically over 27% of annual returns from the
S&P500 come from dividends. This is from all
the stocks in the index, both dividend paying and
not. If you expand that out to 10 years, dividends
account for 48% of the total returns of the S&P
500.
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6. Dividends provide tax advantages. Depending
on where you live, dividends may be taxed
differently than other kinds of income. Check to
see if this produces an advantage for you.
Investors who prefer the buy-and-hold or set-and-
forget approach to their money may find dividend
paying stocks to offer many advantages.
Location: Investors tend to buy stocks from their
home turf. This makes sense. It’s easier to buy
stock held on your country’s exchange and you are
more familiar with domestic companies. However,
there are advantages to diversifying beyond your
borders.
International stocks help you take advantage of
countries whose economies are in a different trend.
They may be rising when yours are stagnant. It gives
you the chance to pick up emerging companies
with good potential. And sometimes the exchange
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Mortimer, Ian & Page, Matthew ‘Why Dividends Matter’, Guinness Atkinson Funds, pg. 4 https://www.gafunds.com/wp-content/uploads/2012/11/
39
ibid, pg. 5
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rate makes foreign stock particularly inexpensive
and attractive.
It can be difficult to buy the foreign stock if it is not
available on your exchange. Sometimes it can be
purchased over the counter (OTC) or off-exchange.
Buying CFDs on the underlying stock also gives you
a great deal of freedom to trade many international
stocks.
Voting Rights: Traditionally, buying stock has given
the stockholder voting rights in the company. This
gives them the right elect board members, vote
on executive compensation, and bring resolutions
or demands to the company for all shareholders
to vote on. If enough shareholders vote for a
shareholder led proposals, they must be enacted.
It takes either a consensus of may shareholders
or the power of a few large shareholders to make
changes contrary to the board’s approval.
Recently some new initial public offerings (IPO)
stocks have been offered without voting rights.
Companies going public for the first time, like Snap,
have management who wants to retain full control
of the company. Just be aware that shareholders of
these kinds of companies have no ability to effect
change within the company should they disagree
with management.
The simplest way to control stocks is by buying
them outright. This can be done with a single stock
or a group of stocks. Recently eToro expanded
their trading to include stock ownership. If you
purchase unleveraged stock on eToro, you will own
the stock. Leveraged or short sales will be executed
with CFDs.
8.3 Ways of Owning or Controlling
Assets
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In Chapter 2 we discussed the advantages owning
stocks, mutual funds, index funds and EFTs. And
how each may be used to help control risks and
diversify your portfolio. We also covered controlling
stocks without actually owning them through
options and CFDs. Here are two other ways of
holding assets.
REITs or Real Estate Investment Trusts are a way
to hold income producing real estate as if it were a
stock. Typically, they own rental units, hospitals, or
businesses. Or they hold the mortgages on these
properties. This kind of equity is required by law
in some countries to pay out a large percentage
of their income to the shareholder; therefore, it
provides a regular stream of income and long term
capital appreciation. It has tax consequences that
are different from other stocks. Here, shareholders
are responsible for taxes on the pass-through
income.
Limited Partnerships can be traded on an
exchange like a stock. This gives you more liquidity
than would otherwise be possible were you to
invest into a company as a business partner. While
most partnerships are in resources - oil and gas,
timber, or pipelines - some are also in real estate or
finance. They have quarterly required distributions.
They act like dividends, but they are mandatory
and can come from sources other than cash ow.
The partnership pays no taxes, so their distributions
are often higher than the average stock. However,
the limited partnership share owners are
responsible for all the taxes, and these taxes can
be complicated.
Investors can own and manage assets in many
ways. Because rights, fees, risks, and rewards all
vary with different kinds of ownership or control, it
pays to understand these different ways. Then you
can choose the right one for your goals, your risk
tolerance, and your investment style.
Your capital is at risk. Past performance does not guarantee future results. This information is for educational purposes and not investment advice.
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