Most investors who put capital in the stock market are familiar with the Industry Classification Benchmark (ICB), which classifies each public company by industry and sector. They use the system largely to research stocks in specific categories, and to draw comparisons among offerings.
Because stocks tend to rise or fall based on underlying factors that affect whole industries, it’s good for investors to know whether a stock’s price moves in the opposite direction of the broad market.
The ICB’s competitor is the Global Industry Classification Standard (GICS), which preceded the ICB. The following explores the Industry Classification Benchmark, how it functions, how it affects investment decisions, and how it compares with the GICS.
Created in 2005 by Dow Jones and the Financial Times Stock Exchange, the Industry Classification Benchmark is basically a type of market classification for stocks. It permits global investors to compare economic trends when deciding where to place capital.
Before including a company in one of its four-tier classifications, the ICB’s independent external advisory committee determines its major revenue source and examines public information. The overarching goal is to assign classifications that most closely represent the companies’ natures.
FTSE Russell, a division of the London Stock Exchange, manages the Benchmark. The system is made up of a classification structure that is currently composed of:
The 11 industries are:
As an example, Gap Inc. is in the Clothing & Accessories subsector within the Personal Goods sector. That sector falls under the Personal & Household Goods super-sector in the Consumer Staples industry.
Also, when a company conducts multiple kinds of businesses that differ markedly, the chief sector is determined by an analysis of audited accounts as well as its director’s report. Classifications may be made based on either the product’s immediate or end use, or the industrial process utilized.
In addition to the NASDAQ OMX, the London Stock Exchange, Taiwan Stock Exchange, Johannesburg Stock Exchange, Singapore Stock Exchange and Euronext use the Industry Classification Benchmark. Borsa Italiana, the Athens Stock Exchange, the SIX Swiss Exchange, Boursa Kuwait, and the Cyprus Stock Exchange have also adopted the system.
Collectively, the exchanges represent over 65% of global market capitalization.
How Does the Industry Classification Benchmark Compare to the Global Industry Classification Standard (GICS)?
The ICB’s rival, the Global Industry Classification Standard, was developed in 1999 through a partnership between Morgan Stanley Capital International and Standard & Poors. Among those that use the GICS are the NOREX Alliance, the Australian Stock Exchange, and the Toronto Stock Exchange. Either the GICS or the ICB have been adopted by all the major indexes. To date, the GICS system currently consists of four levels and 11 sectors, 24 industry groups, 69 industries, and 158 sub-industries.
The sectors include:
As with the ICB, a company’s chief income source is the main factor in determining its main business activity. Other GICS classification factors include market perception and earnings analysis. Companies are assigned classifications at the sub-industry levels.
Both systems provide sector or industry frameworks that allow investors to conduct accurate research and better manage portfolios and asset allocation. They both also foster global comparisons among sectors and industries.
Thus, the two systems are very similar. However, they diverge when it comes to classifications. The two methods of assigning companies to industries are production and market. With the production approach, which is what the ICB uses, companies are classified based on what they produce — even if they are in the same market. Because many businesses offer goods as well as services, ICB classifications can be problematic.
The GICS, though, uses the market-oriented approach when assigning companies to industries. Instead of making distinctions between consumer goods and services, the GICS categorizes based on “consumer discretionary” and “consumer staples,” both of which contain goods and services companies.
Consumer staples companies — supermarkets, for example — sell products and services that are deemed necessities, and so are unlikely to be significantly affected by economic slowdowns. That renders them part of the non-cyclical sector.
As for consumer discretionary companies, they create goods and services that are not necessities. Thus, companies such as hotels, restaurants, and automobile manufacturers tend to be more severely affected by economic downturns.
Note that the vast majority of sector and industry designations exist in both systems. Also, the investor has no say over how a company is classified.
With some 100,000 securities classified, the Industry Classification Benchmark provides investors with a comprehensive data source as well as a categorizing system. The tiers are crafted to support investment strategies that rely upon such classifications.
The ICB also provides investors with two sets of data that are based on time: a daily database is generated at the end of every business day, and at week’s end, another database produces product files that contain all exchanges made that week.
Further, the Industry Classification Benchmark is crucial for investors who follow a sector rotation strategy, in which capital is moved among various sectors based on short-term outlooks.
The ICB does not take into consideration alternative investments such as art, which are on the rise as ways to diversify portfolios. Such investments are not dependent on the ever-changing stock market.
For investors who aim to build a diverse portfolio, a stock’s classification is key. After all, such investors want their holdings spread across a myriad of industries and sectors, as opposed to just a few.
One effective way to understand a portfolio’s risk is to break it down by sector. Doing so can render insight into how one’s investments will respond to industry trends or to macroeconomic factors such as jobless rates and inflation.
Increasingly, investors are turning to investments with low correlations to volatile public markets, and which can provide better protection against inflation and other economic instability. Rather than react every time the market shifts, a savvier move may be to intersperse investments in stocks and bonds with solid nontraditional opportunities that provide predictable secondary income.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
The ICB is used globally to divvy up the market into specific classifications, permitting investors to compare industry trends more fully. It also helps investors diversify exposure to sector- or industry-specific risk. A system drawback, though, is that the system does not account for increasingly popular alternative investments, such as those offered by Yieldstreet.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.