The Global Industry Classification Standard is an efficient and universally accepted tool essential to the investment process

What is the Global Industry Classification Standard?

The Global Industry Classification Standard (GICS) was developed in 1999 by MSCI and S & P Dow Jones Indices to assist investors in diversifying their portfolio by grouping companies according to their shared characteristics, based on the role they perform in the broader economy. The classification standard is universally adopted around the world by professional equity investors because it provides transparency and efficiency in the investment process.

The GICS has 11 Sector classifications:

• Energy
• Materials
• Industrials
• Consumer Discretionary
• Consumer Staples
• Health Care
• Financials
• Information Technology
• Communication Services
• Utilities
• Real Estate

This same structure applies to companies across the full spectrum of the global equity investment market. The GICS is reviewed annually to ensure that the structure accurately represents today’s global markets. Companies are classified according to their principal business activity using revenue as the key measure to identify a company’s principal activity. Earnings are important, however a company engaged in two or more substantially different business activities, none of which contributes sixty percent or more of revenues, is classified by the majority of the company’s revenues and earnings

Why is the Global Industry Classification Standard important?

The mix of exposures to sectors and industries can have a profound impact on investment returns. Factors that influence the earnings performance of one company may have negligible or no impact on the earnings of another company. For example, a company’s shares in the Energy sector are unlikely to be impacted by the same economic pressures as a company in the Healthcare sector, just as Information Technology shares are unlikely to be impacted by the same market influences that might impact the Materials sector.

While sector diversification is important to minimise investment risk, it doesn’t eliminate investment risk. This is because regardless of the extent of diversification, market risk (also known as systematic risk) cannot be diversified away. Market risk affects the performance of the entire market simultaneously. Factors that drive market risk include geopolitical events and recessions. Professional investors can and do reduce market risk by using hedging strategies such as buying put options over specific shareholdings or buying index options to reduce portfolio risk or the risk inherent in certain sectors.

Managing equity risk

Managing risk must always be at the heart of every investment strategy. One of the world’s most successful share investors is Warren Buffet who famously said that ‘Risk comes from not knowing what you’re doing’. In other words, the role of knowledge and understanding of how a particular company makes its money is critical to successful equity investing.

Together with knowledge and understanding, buying quality companies with pricing power and privileged assets, and holding them over the long-term, is the most widely accepted investment strategy adopted by successful investors.