1. Nearly every professional investor has a mandate that they must follow. This mandate (often in the form of a written investment policy statement) requires the money under management to be invested according to a set of rules.
In the case of balanced (non-industry specific) managers, their asset allocation parameters are to be nearly fully invested all the time. The asset allocation decision (how much should go into stocks) is not their call. That decision belongs to the investor.
2. Many such professional investors follow a sector allocation decision process in which they decide which economic sectors warrant an over, even, or under weight position relative to the current Standard & Poor’s mix. For example, the current S&P weighting for consumer staples is 11.65%. That means of the S&P 500 stocks, 11.65% of the market cap is consumer staples.
Now, let me describe how a non-professional can exploit the above. Let’s use the healthcare sector as an example.
The S&P 500 market cap weighting of Healthcare is currently 12.53%. Let’s assume that a non-professional investor concludes that most investors (professional and non) will increase their allocation to the Healthcare sector due to the uncertainties swirling around the market. Since Healthcare is classified as a “defensive” economic sector (one less subject to the volatility of the economic environment), this is a reasonable conclusion.
By itself, this conclusion would lead investors to overweight the sector, say at 15% of the total portfolio. Sector tilting is a good first step toward managing a well diversified portfolio. But let’s go one exploitive step further.
Within the healthcare sector are distinct industry sectors that, while economically influenced by the overall sector, have their own trends and valuation aspects. Four of the largest industries within the healthcare sector are pharmaceutical, biotech, managed care and medical devices. Therefore, while the aggregate healthcare sector may exhibit its overall trend, the individual industries provide their own unique characteristics.
Now we come to the exploitation stage.
Recall that many professional investors must be nearly fully invested. Also recall that many such professionals operate on a sector allocation decision basis. Therefore, while professional investors are compelled to invest in the healthcare sector, they are free to decide which industries are best suited for superior stock price performance.
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