When choosing among the various sectors of the economy,  our firm focuses on two specific criteria;

1.   Superior Investment Performance

2.       Low Correlation

Table 3.2,  Source: “Long-Term Returns on the Original S&P 500 Companies.”  1957-2005 , Jeremy Seigel, Financial Analysts Journal, (Jan/Feb 2006).   Additional returns by  Lipper Inc; A Reuters Company., 2005-2009.   Financials measured by Financial Services Funds, Healthcare by Healthcare/Biotechnology Funds, Energy by Natural Resources Funds, and Technology by Science and Technology Funds.  

In examining the past performance of the major sectors, four maintained superior performance over the S&P 500 Index;  healthcare, energy, technology, and financials. These three sectors all significantly outperformed the S&P 500 stock index for the 50-year period ending December 31, 2007 .   Due to this impressive performance, we utilize these four sectors for a large component of our equity portfolios.   The primary benefit of adding energy stocks are the risk benefits.  Energy stocks are an excellent choice based upon their low correlation to the other three sectors.  They also provide a portfolio hedge against inflation.  Inflation has an adverse impact on the stock market.  In the last two periods of high inflation (1974, 1979), stocks performed very poorly.   We therefore view the energy sector as a key ingredient in a diversified global portfolio.

Our goal as portfolio managers is not only to deliver superior returns to our clients, but also minimize risk.  One advantage of investing in our four recommended sectors are the low historical correlations that these four sectors possess.  Below are the correlations for these four sectors in the previous ten years. 

  Sector       Financials           Healthcare                   Energy             Technology

Financials         1.0                        0.64                       0.45                      0.30

Healthcare                                    1.00                       0.19                      0.07

Energy                                                                       1.00                       0.02

Technology                                                                                            1.00

Source: MSCI World, 1992-2007

The highest correlated sectors are the healthcare and financials; with a 0.64 correlation.   This is considered moderately high.  However, all other correlations within the chart are at a 0.45 or less.  Some relationships are exceptionally low.  Healthcare and technology have a minuscule 0.07 correlation.  Energy and healthcare have a diminutive 0.19 correlation.  These low correlations mean that although these sectors offer high performance, they do so at different times.  Therefore, if healthcare stocks do exceptionally well, one or more of the other sectors is most likely doing poorly.  This see-saw relationship actually lowers volatility.  Due to these findings, these four sectors, in combination, offer our investors the best opportunity to outperform the stock market averages on a risk-adjusted basis.  

Our offered portfolios for individuals, separate account programs, and institutional pension clients utilize this distinctive sector approach.  Approximately 75% of each portfolio is invested in these sectors.  The balance (25%) is invested in other sectors of the economy that we believe offer the most value.  Since inception, our managed portfolios have outperformed their respective indices by a wide margin.  We expect that our distinctive sector strategy will allow us to continue this historical trend of outperformance.

Timothy J. McIntosh, CIO

April 9, 2010