Allocate stocks by country or by industry?
My portfolio, like many others I suspect, is currently divided by countries for investments in stocks. For simplicity I use Canadian, US, and EAFE stock indexes. But as others repeatedly point out a country can be headquartered in the US and make a profit in China. Does it make sense to allocate by country, or would it be smarter to allocate by industry? This question was prompted by The Future for Investors by Jeremy Siegel, which I have recently started reading and which focuses extensively on industries.
It is correct to say that the country you invest in doesn’t mean as much as it used to; the laws and economic conditions can change the costs and taxes of a company but the biggest and best are taking profits from everywhere. Like an amateur investor who diversifies with 5 US large-cap funds (actively managed of course), it can be hard to tell the true exposure you have and you may not be truly diversified geographically. With industry allocations there is less blurring, although a company could operate in one industry while depending on another for sales or supplies.
Another positive element of industry allocations is that those who invest in a rapidly growing country frequently find themselves with average or below-average returns, because the growth doesn’t go to foreign investors. It might be that the right foreign companies operating in the right industries can actually get some of that growth. Emerging markets may be more likely to deliver profits to the developed-world luxury goods marketers who have a new demographic for their brand, rather than the investors in their poorly-regulated stock exchanges.
Allocating by industry could give you more control over your portfolio and maybe even less correlation; all countries can do poorly together, whereas the financial sector can blow itself up while other industries profit from negative trends. Furthermore, you may be able to profit from perceived trends; if technology becomes overvalued once again because of excitement about the future you can safely reduce your allocation to that industry while staying invested in the calmer ones.
Of course this weapon can be turned against yourself if you predict the future of an industry incorrectly. Depending on where you stand this may be much harder to do than predicting the future of a country. Adding to this, an industry’s future direction can be altered by things like government regulation that are difficult to control and predict on top of the variations in the economy. Although Siegel points out several industries that have done well it’s no easy task to predict them in advance and we may look back on them later and say that they just had a bull market for a period of time and then their performance fell off.
For one example I’m not so sure of the future of “consumer staples”, especially big brands of processed foods. As someone who cooks at home I mostly avoid them, and the usual anti-corporate movement might just take hold here in a weaker form. Consumption patterns could change and relegate the industry to the same history as North American manufacturing (which in turn might just grow in the future as people find out that offshore work has been taken to the point of negative gains or over-subsidized in some cases).
In the end all divisions are arbitrary, and all asset classes are inter-related. There is always some exposure that crosses the lines, and a big enough shift in one area will spill over to others. On the whole I haven’t seen nearly enough evidence to convince me that it’s worthwhile to use industry allocations for the current size of my portfolio. It may be of interest in the future though, most likely if I feel that one industry is valued well above the others like in 1999. It may not be applicable yet but I’ll certainly look at news and economic reports in a new light to see if this helps understand what is currently a good investment and where the danger lies.