Friday HighlightSep 24 2021

Taking the first step toward investing

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Taking the first step toward investing
Pixabay via Pexels

Today there are more than 600 companies in the FTSE All Share Index, across 39 sectors. Knowing which sectors to consider, let alone which companies in those sectors to select, is no easy task.

The constant news flow reporting daily winners and losers hinders any straightforward analysis of what might be an attractive place to start. Arguably, stock selection is an art as much as a science, but it is possible to review the broader sectors to determine which look interesting.

For first-time investors, the IT theme should play a key role in any portfolio. However, it requires more thought than just following the traditional confines of sector classifications. 

Historically, it was fairly simple to compartmentalise companies into traditional sectors. Banks and insurance companies, for example, would sit within financials and mining companies would be in the materials sector. More recently, however, the developments we have witnessed across the IT sector has required us to think more laterally about how we define this group.  

Companies that most investors typically associate with IT are often those that give us most cause for concern. They are generally the larger, consumer-facing companies that are synonymous with Silicon Valley where frequently either valuation or the potential for future regulation prevents us from being more enthusiastic. However, companies in other 'traditional' sectors demonstrating an ability to harness the benefits of technology are likely to offer investors material rewards over time.

Health care sector

One such opportunity would be within the health care sector. 

Health care has frequently been in the news for the wrong reasons. Every few years, as another US election loomed, Democrat and Republican candidates would line up to denounce the predatory pricing practices of the large pharmaceutical companies. Alongside the political headwind were the regulatory challenges and in particular, the cost and complexity of bringing a new drug to market.  

But more recently the tide seems to have turned as companies such as Pfizer and AstraZeneca are considered national champions following the role they played in the development of vaccines that have been so instrumental in allowing economies to open up once again.  

A sub-sector of health care is known as med-tech, which we believe will provide investors with exciting opportunities. This can cover many different areas from diagnostics to drug development, all the way through to patient care.

Revisiting the Covid-19 vaccine race, a number of drug companies were able to harness technology to make material breakthroughs. The development of messenger-RNA-based vaccination was crucial in allowing a number of manufacturers to quickly develop and roll out Covid vaccines, enabling them to resolve one of the most significant challenges for a generation. In the future, they will be able to leverage this technology to drive profits in new applications. 

Another example is the emergence of medical equipment that allows remote monitoring of patients. This can provide multiple benefits, not least lower costs and higher efficiency for health care providers but also allowing patients the ability to spend more time at home rather than in hospital.  

Technology has also been instrumental in the developments made within genomics. The first human genome took $2.7bn (£2bn) and almost 15 years to complete. Now, according to certain analysts, genome sequencing and analysis costs around $1,400 and can be done in a few days. 

The applications are only just starting to be understood, but genomic medicine has already shown benefits in refining diagnoses and guiding therapeutic approaches, and is providing numerous health care companies with exciting commercial opportunities. 

However, it is important to remember that each sector is comprised of a myriad of companies that are often only loosely connected and which may have diverging fortunes, meaning any investor should avoid making sweeping generalisations.  

Financial services sector

A topical example can be seen within the financial sector. The risk of inflation and the likelihood of rising bond yields is at the forefront of investor concerns at the present time.  

Such a backdrop is historically viewed as positive for the financial sector for two main reasons. 

The first is that where rates are rising, there is a tendency to assume that the broader economy will be strengthening, allowing customers of banks the ability to continue making loan repayments and resulting in fewer non-performing loans.  

It also means that banks can earn more profit from the spread between what they pay to savers and what they can earn from placing their cash deposits into the market, known as the net interest margin.   

However, this fails to capture the more diverse and complex composition of the financial sector and the longer-term structural challenges facing the banking sector more generally. 

In 2000, 60 per cent of the financial sector in the UK was made up by traditional High Street banks. Today, that figure is 31 per cent, according to financial data company FactSet. The balance now comprising of financial companies where their fortunes are less inextricably linked to the direction of bond yields and interest rates. This would include the rise of fintech businesses, spread-betting companies or even stock exchanges.

The stock market is like a living organism, continually evolving and adapting to the wider environment. It is therefore important, when considering which sectors to invest in, that you are looking forward and not relying on assumptions of old.  

Any investment manager worth his or her salt would start the 'where to invest' conversation with a few questions around attitude to risk, propensity for loss, investment time horizons and objectives.

The answers to these rudimentary questions should help frame the sector and stock selection before any decisions are made. Setting the context for the investor is even more important for a novice or first-timer, and could help prevent very costly mistakes.

Rupert Elwes is head of private clients at Waverton Investment Management