Fisher Investments on Materials

Andrew Teufel, Brad Pyles

• Publisher: Wiley
• Year: 2009
• Print ISBN:
  9780470285442
• Edition: 1
• eBook ISBN:
  9780470621806
• Topic: Business
• Subtopic: Finance
• Index: Business

The second installment of the Fisher Investments On series is a comprehensive guide to the Materials sector. Fisher Investments on Materials can benefit both new and seasoned investors, covering everything from Materials sector basics to specific industry insights to practical investing tactics, including common pitfalls to avoid.

The book will begin with a discussion of Fisher Investments' investing philosophy as it applies to the Materials sector. Then, readers will be lead through a discussion of sector basics , what drives the industries, and develop a framework for individual security analysis. Finally, the book will look at industry fundamentals and discuss what investors can do to protect themselves in a down market.

For more information visit www. materials.fisherinvestments.com

II

NEXT STEPS: MATERIALS DETAILS

4

MATERIALS SECTOR BREAKDOWN

Now you’ve got the basics of how the Materials sector works, an understanding of its history, and its high-level drivers. But a high-level understanding is just the beginning. Just like our overall economy, each sector is made of many distinct parts—some are relatively similar to others and some are quite unique. To better understand the whole, you must understand the parts.

Chapter 1 covered the basic categories of the Materials sector: metals, chemicals, construction materials, and paper. But that’s really an oversimplification—all the metals and chemicals have unique characteristics and drivers. This is also true of the other Materials industries and the sub-industries that comprise them.

Before making any portfolio decision, you must understand what makes each distinct sector component tick. This chapter explores the sector’s sub-industries and how an investor can form an opinion on each.

GLOBAL INDUSTRY CLASSIFICATION STANDARD (GICS)

Before beginning, some definitions: The Global Industry Classification Standard (GICS) is a widely accepted framework for classifying companies into groups based on similarities. The GICS structure consists of 10 sectors, 24 industry groups, 68 industries, and 154 sub-industries. This structure offers four levels of hierarchy, ranging from the most general sector to the most specialized sub-industry:

• Sector

• Industry group

• Industry

• Sub-industry

Let’s start by breaking down Materials into its different components. According to GICS, the Materials sector consists of one industry group (Materials), five industries, and 15 sub-industries. Below are Materials’ industries and corresponding sub-industries.

Metals & Mining

• Diversified Metals & Mining

• Steel

• Gold

• Aluminum

• Precious Metals & Minerals

Chemicals

• Commodity Chemicals

• Specialty Chemicals

• Diversified Chemicals

• Fertilizers & Agricultural Chemicals

• Industrial Gases

Construction Materials

• Construction Materials

Paper & Forest Products

• Paper Products

• Forest Products

Containers & Packaging

• Paper Packaging

• Metal & Glass Containers

GLOBAL MATERIALS BENCHMARKS

What’s a benchmark? What does it do, and why is it necessary? A benchmark is your guide for building a stock portfolio. You can use any well-constructed index as a benchmark—examples are in Table 4.1.

Table 4.1 Benchmark Differences

Source: Thomson Datastream; MSCI, Inc.¹ as of 12/31/07.

By studying a benchmark’s makeup, investors can assign expected risk and return to make underweight and overweight decisions for each industry. This is just as true for a sector as it is for the broader stock market, and there are many potential Materials sector benchmarks to choose from. (Benchmarks will be further explored with the top-down method in Chapter 7.)

Differences in Benchmarks

So what does the Materials investment universe look like? It depends on the benchmark, so choose carefully! The US Materials sector looks very different from Europe, Japan, and the emerging markets. Table 4.1 shows major domestic and international benchmark indexes and the percentage weight of each sector.

Sector weights show each sector’s relative importance in driving overall index performance. While Materials is the third largest weight in the MSCI Emerging Markets index, it’s the smallest weight of any sector in the US-based S&P 500. Why do Materials have more relative weight in emerging markets? Given a wealth of natural resources, but a lack of infrastructure and discretionary income to support other sectors, emerging markets typically have larger Energy and Materials sector weights than developed countries.

Since the weights are representative of the underlying sector and regions’ structures, the weights aren’t fixed and can change over time because of performance differences, additions and deletions of firms to the indexes, and a variety of other factors. For example, Financials wasn’t always the biggest in most indexes. For many decades, Industrials dominated.

Understanding how your benchmark and the sectors within it are structured is crucial to developing a portfolio, since wide deviations in weightings can exist across regions and benchmarks. For example, in some countries, Materials is by far the largest sector; while in others, it’s barely a few percent. Table 4.2 shows the Materials sector’s weight in selected countries, based on the MSCI All Country World Index. Note the stark differences between developed and emerging market countries. For example, Peru’s stock market is dominated by

Table 4.2 Materials Weights by Country

Source: Thomson Datastream; MSCI, Inc.² as of 12/31/07.

Country	Weight (%)
Peru	76.6
Brazil	29.9
Australia	24.5
South Africa	21.1
Mexico	17.2
Canada	16.8
Germany	14.9
UK	10.8
Russia	10.7
France	9.1
India	7.9
China	6.9
US	3.5
Spain	0.6
Italy	0.4

Materials—mainly mining firms—but the big, diverse US market is near the bottom of the list with only a 3.5 percent Materials weight.

Not only can sector weights vary, but so can industry weights—sometimes greatly, depending on the chosen benchmark. Table 4.3 shows the weight of each Materials industry within each benchmark.

Understanding these weights allows you to not only properly weight your portfolio relative to your benchmark, but also effectively utilize your time by focusing on the most important components. (And for this reason, this book focuses more on the two largest industries—Metals & Mining and Chemicals—and less on the smallest industry—Containers & Packaging.)

Metals & Mining is the largest Materials industry in most broad global and non-US benchmarks. Because the industry is concentrated in dominant foreign mining firms, it has a much smaller US weight (Chemicals hold the largest US weight). The Metals & Mining industry also has less impact on small cap indexes (like the Russell 2000) because much of its weight is concentrated in larger firms. This wasn’t always the case, but as machines have replaced manual labor and fixed costs have risen as a percentage of total costs, the benefits of economies of scale have grown and so have the firms.

Table 4.3 Materials Industry Weights

Source: Thomson Datastream; MSCI, Inc.³ as of 12/31/07.

It’s important to consider regional composition as well. In a top-down context, local economic and political conditions have a large impact on sector, industry, and sub-industry performance. For example, if the US outperforms, that bodes well for the Chemicals, Paper & Forest Products, and Containers & Packaging industries—all with large US weights relative to the rest of the sector. For a similar reason, if the emerging markets outperform, Metals & Mining and Construction Materials should benefit. Using the MSCI All Country World Index (ACWI), Table 4.4 shows the regional distribution of global Materials industries.

Table 4.5 further breaks down sector sub-industry weights (largest weights by index are bolded). Gold made a lot of headlines in 2007 and 2008, but note it makes up just 0.4 percent of the MSCI World Index and 6.1 percent of the MSCI World Materials sector. It’s an even smaller weight in most other benchmarks. You could ignore gold altogether and not significantly impact your ability to outperform most Materials benchmarks.

Table 4.4 Materials Industries by Regions

Source: Thomson Datastream; MSCI, Inc.⁴ as of 12/31/07.

Diversified Metals & Mining has the most impact in global indexes, because it contains firms producing copper, iron ore, and coal, the three largest revenue sources for global mining companies.

Notice how the structure of industries described in Chapter 1 influences the weightings across indexes in Table 4.5. For example, Commodity Chemicals has its greatest weight in Emerging Markets and Specialty Chemicals has its greatest weight in the small cap Russell 2000 Index. Can you guess why? Because commodity chemicals are priced globally and compete fiercely on production costs, producers have migrated to regions with the lowest cost of production. By comparison, specialty chemicals are priced regionally and serve niche markets, so a host of small regional producers exist.

Even Broad Indexes Have Cracks

Stock market indexes only track publicly listed firms in designated countries. No index tracks every firm. Some of the largest holders of natural resources in the world are governments, and others are in very small markets that most indexes do not include. This means some of the world’s largest mineral producers are not reflected in most, if any, stock market indexes. For example, Codelco, the largest copper producer in the world, is owned by the government of Chile and not included in any indexes. Saudi Basic Industries, the world’s largest chemical company, is based in Saudi Arabia and included in very few of the broadest global indexes.

A Concentrated Group

When determining your over- and underweights to the benchmark for the Materials sector, it’s important to have an opinion on (or at least knowledge of) the sector’s largest companies. Recall from Chapter 1 that s...

Table of contents

• FISHER INVESTMENTS PRESS
• Title Page
• Copyright Page
• Foreword
• Preface
• Acknowledgements
• I - GETTING STARTED IN MATERIALS
• II - NEXT STEPS: MATERIALS DETAILS
• III - THINKING LIKE A PORTFOLIO MANAGER
• Appendix A Materials Sector Resources
• Appendix B Top 10 Materials Firms by Industry
• Notes
• Glossary
• About the Authors
• Index