When it comes to the share market, diversification is not only about investing in shares from different sectors of the market.
While having exposure to different industries is a good idea, I think investors should also consider the different 'types' of shares that can be used to further diversify a portfolio.
So what 'types' of shares am I talking about?
Perhaps the best way of explaining this is through the use of some examples that I have highlighted below.
Defensive
These types of shares are largely immune to the swings of the economic cycle. Healthcare shares like CSL Limited (ASX: CSL) and Sonic Healthcare Limited (ASX: SHL) are two good examples as consumers will continue to need their products and services even during economic downturns. Other classic defensive shares include the supermarket giants.
Interest rate sensitive
These types of shares are sometimes called 'bond-proxies' as their shares prices can be impacted by changes in the bond markets. These shares are typically defensive in nature and offer a pretty good dividend yield. Infrastructure shares like Sydney Airport Holdings Ltd (ASX: SYD) and Transurban Group (ASX: TCL) as well as utility and property shares are the main examples of interest rate sensitive shares.
Cyclical
The success of cyclical shares is usually linked closely with general economic growth or with growth in a particular sector. The best time to buy these shares is at the bottom of the growth cycle. Some common examples of cyclical shares are discretionary retailers like Nick Scali Limited (ASX: NCK) and mining companies like BHP Billiton Limited (ASX: BHP).
Growth
Growth shares are expected to grow their profits at an above average rate and usually trade on high earnings multiples. Although they can provide a real boost to your overall portfolio if purchased at the right price, they can certainly come crashing down if they miss market expectations. Some of the best growth shares on the ASX right now include Corporate Travel Management Ltd (ASX: CTD) and Webjet Limited (ASX: WEB).
Income
Income shares pay out a large proportion of their profits in the form of dividends. They usually trade on fairly undemanding earnings multiples as they have limited growth prospects. The classic example is Telstra Corporation Ltd (ASX: TLS), although the banks could be classified as income shares as well.
Growth at a reasonable price (GARP)
This is my favourite type of share as it usually represents an attractive value proposition. Perhaps the best way of measuring value in this case is through the use of the price-to-earnings growth (PEG) ratio. Shares with a PEG of less than 1 typically present good value for their growth potential. RCG Corporation Ltd (ASX: RCG) and Retail Food Group Limited (ASX: RFG) are two good examples of this type of share.
Speculative
Speculative shares are usually those with a limited track record and/or are usually unprofitable. These shares should never make up a large proportion of your portfolio as the risk of permanent loss is large. With that said, there is nothing wrong with a small speculative holding and two of my favourite speculative shares right now are ChimpChange Ltd (ASX: CCA) and Smart Parking Ltd (ASX: SPZ).
Foolish takeaway
Most shares will inevitably fall into a number of categories but understanding how the market views a particular share at a particular time can provide you with an important tool to construct your ideal portfolio.
