Many strategies (including passive ones) hold large allocations to Information Technology. A “barbell” approach can mitigate risk from high exposure to one sector by pairing it with another.

Do you remember sending your first email? For many, it was likely around the mid-1990s when a “googol” was still 10^100 rather than a verb and the @ key on your keyboard was seldom used. The world has changed indeed. In 1995, the Information Technology sector comprised just 10% of the S&P 500^® but soon rocketed to 35% by March 2000 before a bursting bubble started its Icarian descent back below 20% (see Exhibit 1). By 2021, Information Technology reached a peak weight of 28% as the largest of the 11 S&P 500 sectors before leading the market downward this year.

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Because each S&P 500 sector uses the Global Industry Classification Standard^® (GICS^®) to group businesses that are similar, sectors tend to exhibit non-aligned periods of outperformance. On any given day since December 2000, 51% of sectors have outperformed over a trailing six-month period. We find that whenever Information Technology has underperformed the S&P 500 during a six-month period, all 10 other GICS sectors have, on average, outperformed the benchmark (see Exhibit 2).

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A recent example of sectors exhibiting different performance profiles can be seen in Energy and Information Technology since the emergence of COVID-19 in December 2019 (see Exhibit 3). While Information Technology has exhibited defensive resilience during the pandemic-related tumult, it has traditionally been viewed as a more cyclical sector that benefits from periods of economic strength and market optimism toward future earnings, Energy tends to be a necessary purchase for consumers and businesses throughout the economic cycle (barring pandemic-driven reduced fuel demand). Some investors may eschew Energy when Information Technology is on the rise, but it has demonstrated usefulness as a diversifier of risk and return.

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Historically, combining the Information Technology sector with less-correlated sectors has reduced risk and aided long-term performance. For illustration, we constructed an equal-weighted three-sector hypothetical blend of the S&P 500 Information Technology, S&P 500 Energy, and S&P 500 Consumer Staples (rebalanced monthly) and compared it with the performance of the S&P 500 Information Technology alone during the first year of the 2000 dot-com crash as well as during the YTD 2022 downturn (see Exhibit 4).

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Extending the study period of the three-sector blend since 2000, we find that the combination of the three-sector blend not only exhibited similar annualized volatility (19.33%) to the S&P 500 (19.61%) but also produced higher cumulative return (578.06%) than the S&P 500 (374.19%) as well as the individual sector components thanks to diversification and regular rebalancing.

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Although the path of any individual sector over time can be difficult to predict, data suggest that long-term diversification qualities among the S&P 500 sectors have been robust. If one sector bet goes wrong, others tend to go right. With 11 sectors to choose from, investors are equipped with time-tested tools to make thoughtful pairings and navigate their investing strategies through the cycle.