Seeking greener pastures

Most specialists, like bankers, don't hold stocks of their own sector

What do you look for in a stock? It depends on the time perspective and willingness to take risks. Out-and-out traders look for the price target in the next hour or the next two days. Momentum players look for stocks that have been trending up consistently for longer periods. 

 

Long-term investors have more varied styles and strategies. Any of these work some of the time and none work all the time. Some look for reasonable businesses at reasonable prices. Some for great businesses at reasonable prices. Some look for great businesses at any available price. Others go to an opposite extreme: They buy even poor businesses if those seem under-priced. Some seek dividend plays. Others chase cyclical stocks, while others invest in low cyclicality.

 

One type of investor is rather rare. This is the individual who specialises in one sector. Yet, if you think about it, specialisation of this kind makes a lot of sense. Fund houses, rating agencies and investment banks all deploy sector-specialists. An analyst who tracks a given industry or sector continuously will inevitably know more about it than a generalist. Every so often, extra knowledge will translate into excess returns. However, there are also some dangers in deploying specialists.

 

An analyst who tracks one sector will develop long-term relationships with key people working there. That is, in itself, useful. But, those relationships can turn into conflicts of interest. Indeed, analysts often soft-pedal bad news or play up good news to maintain relationships. This is one reason why ‘sell’ recommendations are uncommon.

 

Most  individual investors need not worry about similar conflicts of interest. They don’t have to make public recommendations. They also have a ‘day-job’, which means they are connected to some sector and  already have some expertise in it. This doesn’t mean people should invest on inside information or rumours. Without taking any such undue advantage, people within are always in a better position to know the overall health of a sector and relative competitive positions of various companies.

 

Again, this doesn’t require either knowledge or understanding of financial details or information that is considered sensitive. People working within an industry are usually well aware about that sector’s health. Even casual blue-collar labourers know if wages are paid promptly, and if there’s demand for more workers and overtime, etc.

 

Any given sector will go through periods when it looks attractive to investors and periods when it is not. Workers within that sector will always have an edge on judgement calls about such periods and transitions. Quite often, insiders will know about changes in the sector’s fortunes long before it becomes obvious on balance sheets. Sometimes, they will raise the alarm early — as telecom sector employees did, two years ago. Sometimes they will be able to signal a positive turnaround, as steel industry workers did about a year ago. 

 

An investor who only invests within a sector of expertise has that extra margin of safety and is probably likely to time things a little better than outsiders or generalists. However, what does such an investor do during periods where that sector is unattractive? One strategy would be to stick to systematic passive investments . In that case, the portfolio will be well-diversified via mutual funds, while being overweight in the sector of choice. 

 

People do also get employment in areas where there aren’t a great deal of investment-worthy companies. For example, government employees in sectors like the defence services or the railways have little or nothing in the way of listed options in their respective areas of expertise. However, as these sectors open up, individuals employed in these will see increasing interactions with  listed businesses and that could translate into investment opportunities. 

 

I know a few individuals who have been focused on one sector of expertise and they've usually done well. But, oddly enough, I don’t know too many doctors who are heavily overweight on pharmaceuticals, or information technology (IT) industry people who are overweight on IT stocks (apart from employee stock options). Most bankers don’t seem to hold an array of banking stocks either. It must be a psychological quirk — the grass is always greener elsewhere.