Glossary: Sector and Style Investing Terms
This glossary covers key terms for sector allocation, style investing, and global equity strategies. Terms are organized alphabetically with cross-references to related concepts.
Active Share — A measure of how different a portfolio is from its benchmark, calculated as the sum of absolute weight differences divided by two. An active share of 60%+ indicates meaningful deviation from the index; below 20% suggests closet indexing. Related: Tracking Error.
ADR (American Depositary Receipt) — A US-traded security representing shares of a foreign company, held by a depositary bank. Sponsored ADRs involve company participation; unsponsored ADRs are created without company involvement. ADR holders face currency risk and dividend withholding taxes. Related: Currency Risk, Home Bias.
Alpha — Return above what would be expected given a portfolio's risk exposure (beta). Positive alpha indicates outperformance after adjusting for market risk. Often quoted in basis points (1% = 100 bps).
Benchmark — A reference index against which portfolio performance is measured. Sector investors commonly use GICS sector indices (e.g., S&P 500 Technology Index) or broad market indices (S&P 500, Russell 3000).
Beta — A measure of a security's volatility relative to the market. Beta of 1.0 means the stock moves with the market; >1.0 indicates higher volatility; <1.0 indicates lower volatility. Technology typically has beta >1.0; Utilities typically <1.0.
Breadth — The number of stocks participating in a market move. High breadth (many stocks rising) confirms trend strength. Narrow breadth (few stocks leading) signals fragile rallies. Common breadth measures: percentage of stocks above 50-day moving average, advance-decline line. Related: Momentum.
Concentration Risk — The risk from having portfolio weight heavily tilted toward specific stocks, sectors, or regions. The S&P 500's top 10 stocks represent >30% of index weight as of 2024, creating concentration in mega-cap tech.
Currency Risk — The risk that exchange rate movements affect returns on foreign investments. A US investor in a Japanese stock gains (or loses) based on both the stock's local return and the USD/JPY exchange rate change. Related: ADR, Hedged ETF.
Cyclical Sector — Industries whose performance correlates strongly with economic growth. Cyclical sectors include Consumer Discretionary, Industrials, Materials, Financials, and Energy. These typically outperform during economic expansions and underperform in recessions. Related: Defensive Sector, Sector Rotation.
Defensive Sector — Industries with relatively stable demand regardless of economic conditions. Defensive sectors include Consumer Staples, Utilities, and Healthcare. These typically outperform during recessions but lag during expansions. Related: Cyclical Sector.
Direct Indexing — Owning individual stocks that replicate an index, rather than buying an ETF. Enables tax-loss harvesting at the individual position level and customization (ESG screens, concentration limits). Typically requires $100,000+ minimum account size. Related: Tax-Loss Harvesting.
Equal-Weight — An index methodology where all constituents receive identical weights (e.g., 0.2% each in a 500-stock index), regardless of market cap. Equal-weight indices (like RSP for S&P 500) give more weight to smaller companies than cap-weighted indices.
ESG (Environmental, Social, Governance) — Investment criteria beyond financial metrics, screening companies based on environmental impact, labor practices, board structure, and similar factors. ESG screens can be negative (exclusion) or positive (overweighting leaders).
Factor Investing — Systematically targeting characteristics (factors) that historically explain return differences among stocks. Major factors: Value, Momentum, Quality, Size, Low Volatility. Factor strategies attempt to capture premiums associated with these characteristics. Related: Smart Beta.
GICS (Global Industry Classification Standard) — The dominant sector classification system, maintained by MSCI and S&P. GICS organizes stocks into 11 sectors, 25 industry groups, 74 industries, and 163 sub-industries. Most sector ETFs and indices use GICS classifications.
Growth Investing — A style emphasizing companies with above-average revenue and earnings growth, typically trading at higher P/E multiples. Growth investors prioritize sales growth, market expansion, and reinvestment over current profitability. Related: Value Investing, Style Box.
Hedged ETF — An ETF that uses currency forwards or futures to neutralize exchange rate exposure. Hedged international ETFs (like HEFA for EAFE) deliver returns closer to local currency performance, eliminating currency as a return driver. Hedging has a cost based on interest rate differentials.
Home Bias — The tendency for investors to overweight domestic securities relative to global market capitalization. US investors often hold 70-80% domestic equities despite the US representing approximately 60% of global market cap.
Industry Group — A GICS classification level below sector but above industry. The 11 GICS sectors contain 25 industry groups. Example: Technology sector contains "Software & Services" and "Technology Hardware & Equipment" industry groups.
Low Volatility — A factor strategy targeting stocks with below-average price volatility. Low-volatility strategies aim to capture similar returns to the market with lower drawdowns. Historically, low-volatility stocks have delivered higher risk-adjusted returns than theory predicts (the "low-volatility anomaly").
Market Cap Weighting — Index methodology where companies are weighted by their market capitalization (share price × shares outstanding). Larger companies receive proportionally higher weights. The S&P 500 is market-cap weighted, so Apple's 7% weight reflects its size relative to other constituents.
Momentum — A factor and strategy based on the observation that recent winners tend to continue outperforming. Momentum strategies buy stocks with strong 6-12 month relative performance and sell laggards. Sector momentum applies this concept across industries. Related: Relative Strength, Breadth.
Quality — A factor targeting companies with strong profitability, stable earnings, and conservative balance sheets. Quality metrics include ROE, earnings stability, low debt-to-equity, and consistent margins.
Relative Strength — A measure comparing one asset's performance to another (typically a benchmark). Rising relative strength (sector outperforming S&P 500) indicates leadership; falling relative strength indicates lagging. Calculated as price ratio: Asset Price / Benchmark Price. Related: Momentum.
Sector — The broadest GICS classification level. The 11 GICS sectors are: Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, and Utilities.
Sector Rotation — The strategy of shifting portfolio weights among sectors based on business cycle position, relative valuations, or momentum signals. Classic rotation: Financials and Industrials in early recovery → Technology in expansion → Utilities and Staples in late cycle/recession. Related: Cyclical Sector, Defensive Sector.
Size Factor — The premium historically associated with small-cap stocks over large-caps. Small-cap stocks have historically delivered 2-3% higher annual returns with higher volatility. The small-cap premium has diminished in recent decades.
Smart Beta — Index strategies that use alternative weighting schemes (not market-cap) to target specific factors. Smart beta products weight by fundamental metrics (sales, dividends), equal weight, or factor scores. Smart beta sits between passive cap-weighted indexing and active management.
Style Box — A visual framework (popularized by Morningstar) categorizing funds by market cap (large/mid/small) and style (value/blend/growth). The resulting 3×3 grid helps investors understand portfolio positioning.
Tax-Loss Harvesting — Selling securities at a loss to realize capital losses that offset gains elsewhere, reducing current-year taxes. Direct indexing enables harvesting at the individual stock level; ETF investors can only harvest losses on the entire fund. Related: Direct Indexing, Wash Sale.
Thematic Investing — Investing based on long-term secular trends rather than traditional sector classifications. Common themes: artificial intelligence, clean energy, aging demographics, cybersecurity. Thematic funds often cut across multiple GICS sectors.
Tracking Error — The standard deviation of a portfolio's returns versus its benchmark. Low tracking error (<1%) indicates close benchmark adherence; high tracking error (>5%) indicates significant deviation. Related: Active Share.
Value Investing — A style emphasizing stocks trading below intrinsic value, typically with low P/E, P/B, or EV/EBITDA ratios. Value investors prioritize current earnings, dividends, and assets over growth potential. Related: Growth Investing, Style Box.
Wash Sale — An IRS rule disallowing loss deductions if a "substantially identical" security is purchased within 30 days before or after the sale. Wash sale rules prevent investors from realizing losses while maintaining continuous exposure. Direct indexing navigates this by substituting similar-but-not-identical stocks.
Note: This glossary will be updated as new terms become relevant. For deeper coverage of specific topics, see related articles in the Global and Sector Investing section.