Sector Investing: Essential Building Blocks for Portfolio Construction April 30, 2014 Brett Hammond Managing Director Head of Index Applied Research MSCI Matthew Goulet, CFA Vice President Sector Investment Strategy Fidelity Investments 2014 MSCI Inc. All rights reserved. msci.com 1
Sector investing has grown significantly over the years: Why do you think that is?
Sector exposure has been a significant driver of returns Investors often ignore key performance drivers when constructing portfolios AVERAGE SOURCE OF RETURNS FOR U.S. STOCKS 12/31/90 12/31/13 61% Company 22% Sector 83% of performance driven by sector and company selection Market capitalization 4% 13% Style Source: Fidelity Investments as of 12/31/13, based on rolling 12-month analysis of variance (ANOVA), which uses statistical models to attribute the variance of a variable (stock returns in the Russell 3000 ) to certain factors (sector, style, and market cap). The residual is attributed to other company-specific factors. Past performance is no guarantee of future results. It is not possible to invest directly in an index. All market indices are unmanaged. Index performance is not meant to represent that of any Fidelity mutual fund. 3
Why Sector Investing? Investors have traditionally made allocations around countries and fundamental style factors Contribution of Style, Industry and Country Factors to MSCI USA IMI Index Returns Dec 1997 to Feb 2014 Markets have realized the growing importance of sectors (industries) Between 2003 and 2009, industry was the most dominant factor in Developed Markets Sector exposures have been influential in driving portfolio risk and return and are important criterion in asset allocation *Cross-sectional volatility (CSV) is defined as the standard deviation of a set of asset returns over a period. It represents the opportunity set for active portfolio management. For instance, if the dispersion of stock returns is very small, then all stocks behave similarly and there is little opportunity to outperform the market. Conversely, when CSV levels are high, performance differences among active managers are more pronounced, 2014 MSCI Inc. All rights reserved. msci.com 4
Based on the Global Industry Classification Standard (GICS) Jointly developed by MSCI and S&P to meet the need for an accurate, complete and standard industry definition Widely accepted as an industry analysis framework The GICS structure consists of 10 sectors, 24 industry groups, 67 industries and 156 sub-industries Benefits: Universal Accurate Comprehensive Evolving Global Sectors (10) Energy Materials Industrials Consumer Discretionary Consumer Staples Healthcare Financials Information Technology Telecommunication Services Utilities 2014 MSCI Inc. All rights reserved. msci.com 5
What role can sector investing play in a client s portfolio?
Potential Role That Sector Indexes Can Play in a Portfolio 1. Alpha seeking strategies Different sectors have thrived in different stages of the business cycle, for example: Consumer Staples acted defensively in volatile markets and performed better during recessionary periods Information Technology has exhibited growth characteristics and performed well during economic expansions 2. Diversification benefits Low correlation among sectors, particularly between cyclical and defensive 3. Low turnover Historically, sector classifications are very stable 300 275 250 225 200 175 150 125 100 75 50 Relative Performance of USA IMI Sector Indexes vs MSCI USA IMI USA IMI Financials USA IMI Energy USA IMI Info Tech USA IMI Utilities USA IMI Cons Staples 2014 MSCI Inc. All rights reserved. msci.com 7
Examples of Using Sector Indexes in Equity Portfolios Composite index comparisons: MSCI USA IMI (50% weight) + All MSCI USA IMI Sector Indexes at 5% weight each Characteristic USA IMI Composite 1: USA IMI + Equal Weight All Sectors Composite 2: USA IMI + Defensives Composite 3: USA IMI + Defensives + Cyclicals MSCI USA IMI (50% weight) + Defensive Sectors at 16.67% weight each (Consumer Staples, Health Care, Utilities) MSCI USA IMI (50% weight) + Defensive Sectors at 8.33% weight each + Cyclical Sectors at 8.33% weight each (Industrials, Information Technology, Materials) Total Return* (%) 5.2 5.9 6.6 6.3 Total Risk* (%) 16.1 15.3 12.6 15.0 Return/Risk 0.32 0.39 0.52 0.42 Sharpe Ratio 0.24 0.29 0.37 0.32 Information Ratio NA 0.39 0.23 0.49 Historical Beta 1.00 0.95 0.74 0.92 Turnover** (%) 2.9 6.5 6.3 6.6 * Annualized in USD, Gross from 05/31/1999 to 03/31/2014 ** Average annual one-way index turnover from 05/31/1999 to 03/31/2014 Allocating to low correlated sector indexes have historically provided substantial diversification benefits, with higher returns and higher Sharpe Ratios 2014 MSCI Inc. All rights reserved. msci.com 8
Some investors think of sectors as risky: Do you agree?
Risk & Return Across Sectors Historically, sectors have featured very different risk/return profiles Defensive sectors such as Consumer Staples, Health Care, and Utilities had lower risk and significantly lower historical beta compared to the parent, MSCI USA IMI Information Technology had the highest historical beta and risk but cyclical sectors such as Consumer Discretionary and Industrials showed similar properties Energy, Consumer Staples and Health Care provided long-term outperformance, but other sectors displayed more cyclical phases of out- and underperformance 2014 MSCI Inc. All rights reserved. msci.com 10
What are the advantages of MSCI USA Sectors IMI over other US sector indexes?
MSCI USA Sectors IMI Broader Market Coverage 2,400 constituents across the large, mid and small caps 99% of the US Equity market vs. about 80% for S&P Select Sectors The Small Cap Premium Potential MSCI USA IMI Sector Indexes include small caps, while S&P Select Sector Indexes do not Over the past 15 years, small caps have outperformed large and mid caps US Equity Market S&P Select Sector Indexes 80% coverage MSCI USA IMI Sector Indexes 99% coverage Greater Diversification Large, mid and small caps often behave differently under various market scenarios 2014 MSCI Inc. All rights reserved. msci.com 12
What is Fidelity doing to help educate clients?
Buying Fidelity MSCI Sector Index ETFs Comprehensive passive sector coverage Why Fidelity Sector Index ETFs? Bringing together Fidelity s expertise and BlackRock s infrastructure, the Fidelity MSCI Sector Index ETF suite provides world class comprehensive, transparent, and efficient exposure to all 10 sectors of the market. Purchase Information Net Expense Ratio: 0.12% Stock Exchange: Fidelity Trading Fees 1 : NYSE Arca Commission Free/30-day short-term trading fee 1 Tickers and Fund Names FDIS Fidelity MSCI Consumer Discretionary Index ETF FIDU Fidelity MSCI Industrials Index ETF FSTA Fidelity MSCI Consumer Staples Index ETF FTEC Fidelity MSCI Information Technology Index ETF FENY Fidelity MSCI Energy Index ETF FMAT Fidelity MSCI Materials Index ETF FNCL Fidelity MSCI Financials Index ETF FCOM Fidelity MSCI Telecommunication Services Index ETF FHLC Fidelity MSCI Health Care Index ETF FUTY Fidelity MSCI Utilities Index ETF 1 Free commission offer applies to online purchases of Fidelity ETFs in a Fidelity brokerage account with a minimum opening balance of $2,500. The sale of ETFs are subject to an activity assessment fee (of between $0.01 to $0.03 per $1000 of principal) by Fidelity. After 02/01/2014, Fidelity ETFs are subject to a short-term trading fee by Fidelity, if held less than 30 days. For Institutional Use Only 14
Appendices
MSCI: The Index That Leads 94 of top 100 global investment managers are 700+ ETFs are based on MSCI indexes, more than on any other index 4 Approximately $8 trillion in assets is estimated to be benchmarked to MSCI indexes 3 MSCI clients 1 95% 150,000 Indexes calculated daily 9,000+ in real-time 99.96% Accuracy rate 2 of US pension fund assets invested in global equities are benchmarked to MSCI 5 1 As of March 2013, based on P&I and MSCI data 2 Accuracy calculated based on number of corrections performed over total number of securities or data points covered. 3 As of September 30, 2013, as reported on January 31, 2014 by evestment, Lipper and Bloomberg. 4 Listed and cross-listed as of March 2014. 5 As of December 31, 2012, according to Intersec LLC. 2014 MSCI Inc. All rights reserved. msci.com 16
Important Information Investing involves risk, including risk of loss. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Risks Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Because of their narrow focus, sector funds tend to be more volatile than funds that diversify across many sectors and companies. Each sector fund is also subject to the additional risks associated with its particular industry. Exchange traded products (ETPs) are subject to market volatility and the risks of their underlying securities which may include the risks associated with investing in smaller companies, foreign securities, commodities and fixed income investments. ETFs are subject to management fees and other expenses. ETPs that target a small universe of securities, such as a specific region or market sector are generally subject to greater market volatility as well as the specific risks associated with that sector, region or other focus. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses and tracking error. An ETP may trade at a premium or discount to its Net Asset Value (NAV) (or indicative value in the case of ETNs). Each ETP has a unique risk profile which is detailed in its prospectus, offering circular or similar material, which should be considered carefully when making investment decisions. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund. Not FDIC insured. May lose value. No bank guarantee. Not NCUA or NCUSIF insured. May lose value. No credit union guarantee The Russell 3000 Index is a market capitalization-weighted index measuring the performance of the 3,000 largest U.S-domiciled companies. Third-party trademarks and service marks are the property of their respective owners. All other trademarks and service marks are the property of FMR LLC or an affiliated company. Before investing, consider the exchange traded product or fund s investment objectives, risks, charges, and expenses. Contact Fidelity or visit advisor.fidelity.com for a prospectus, or a summary prospectus if available, containing this information. Read it carefully. Fidelity Investments Institutional Services Company, Inc., 500 Salem Street, Smithfield, RI 02917. 685690.1.0
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