How to manage the balancing act

Most active fund managers are aware of their stock weighting, industry diversification and performance relative to a major index.

Each index — we will use the FTSE 100 for this exercise — can be broken down into the various sectors that make up the index. The FTSE 100 is quite energy and mining weighted, making up nearly 35% of the index, as a contrast, technology just 1%. If a fund manager wants exposure to the technology sector, it is very hard to gain it through the FTSE 100. If the mining and energy sectors are out of favour globally, the FTSE 100 is likely to underperform other indices. The DAX, the index of leading German companies, is far more weighted to industrials and banking for example.

A fund manager, who invests in European stocks, will decide which sectors he believes will do well over the year and which will do poorly and position himself accordingly. A balanced pension fund manager’s role is to perform better than the overall index, as that is what he is judged on. 

For example, if he believes mining stocks will do well this year against consumer goods, in the FTSE 100 he would buy more than the benchmark 15% weighting mining in his portfolio, and compensate that by owning less than the benchmark 13% in consumer goods stocks. If mining outperforms consumer goods he will outperform the index, visa versa he will underperform the FTSE 100.

As equity markets in Europe have started the year with modest gains, I thought it was worthwhile looking at how the sectors have performed. Indices can often show modest changes but within it one can see material sector movements. We can compare the sector performance with the fund manager weightings in the Merrill Lynch Fund Manager Survey conducted at the end of 2013, to get a sense of how well fund managers have started the year.

Good news for fund managers:
- Where they have got it right is in Banks and Autos, both overweights, both outperforming the market so far this year.
- The biggest overweight was the Insurance sector, up 1% on the year.

Bad news for fund managers:
- The best performing sectors in Europe so far this year have been Travel, Telecoms and Construction, all sectors according to the Merrill Lynch fund managers survey investors were underweight in at the start of 2013. 
- The Resource sector is another one which fund managers viewed cautiously, but has so far outperformed the market.
- One of the worst sectors is Technology, which is so far this year is down 1%; Technology was one of the big overweight’s, according to the survey, for fund managers.

It is early days yet and a lot can change, but a few fund managers may be concerned as to how well positioned they are for the year ahead. One more interesting indication according to Merrill Lynch, the most overvalued and over-owned sectors coming into 2014 were Media and Healthcare, the most undervalued and under-owned Mining and Energy.

Below is a chart that shows the sector weightings for the FTSE 100. The weight of each segment is the total market cap of the constituents.


Posted on January 22, 2014 .