Sector Allocation Calculator

Expected portfolio return is linear in the weights, so the weighted sum of sector returns is exact. Risk is not: the variance of a combination depends on covariances as well as individual volatilities, and a simple weighted average of sector standard deviations would overstate portfolio risk whenever sectors are less than perfectly correlated. This model applies a diversification factor derived from the number of funded sectors and an assumed average pairwise correlation of 0.4, which is roughly where large-cap sector index correlations have historically sat outside crisis periods. The Sharpe ratio then divides excess return over an assumed 4 percent risk-free rate by that adjusted volatility, so improving the ratio means shifting weight toward sectors whose extra return more than pays for the extra variance they add. Concentration is reported through the Herfindahl-Hirschman Index, the sum of squared weights scaled by 10000. Eleven equal sector weights give an HHI near 900, a value under about 1500 is conventionally read as diversified, and above 2500 as concentrated; a single-sector portfolio scores 10000. For reference, the S&P 500 sector weights are themselves fairly concentrated, with information technology alone near 30 percent in recent years. The important caveat is that a single assumed correlation cannot describe real market behaviour: correlations rise sharply in sell-offs, so the diversification benefit shrinks exactly when it is needed, and the low and high projection bands here represent one standard deviation of annual return applied every year rather than a genuine distribution of outcomes.

Grouping listed companies by industry is old practice, but the classification underlying most sector allocation work today is the Global Industry Classification Standard, developed jointly by MSCI and Standard and Poor's and launched in 1999 to replace inconsistent national schemes. It assigns each company to one sector based on its principal source of revenue. The scheme has been revised as the economy changed: real estate was separated from financials into its own sector in September 2016, and telecommunication services was broadened into communication services in September 2018, absorbing media and interactive services companies from technology and consumer discretionary. The analytical framework predates the classification. Harry Markowitz set out mean-variance portfolio selection in a 1952 paper in the Journal of Finance, showing that the risk of a portfolio depends on covariances rather than the average risk of its holdings, work for which he shared the 1990 Nobel prize in economics. William Sharpe added the ratio of excess return to volatility in 1966, giving a single number for comparing allocations. The concentration measure was developed independently by Albert Hirschman, who used it in 1945 to study trade concentration, and Orris Herfindahl, who applied it to the steel industry in 1950; United States antitrust authorities adopted it in the 1982 merger guidelines, and portfolio analysts borrowed it afterwards. Sector-level implementation became practical for ordinary investors when State Street launched the Select Sector SPDR exchange-traded funds in December 1998.