Investors who want to beat the market and learn to invest might want to consider a an Exchange Traded Funds (ETF) sector rotation strategy. ETFs that concentrate on specific industry sectors offer investors a straightforward way to participate in the rotation of an industry sector. Using market sector rotation, many investors overweight their portfolios in strong sectors and underweight in weaker sectors.
Each industry sector tends to perform better at different stages of the economic cycle. The performance of these sectors can be a factor of the stage of the business cycle, the calendar, and their geographic location. Investors seeking to beat the market would do well to identify which sectors are most likely to do well in the near future and overweight their portfolios accordingly.
This is where sector based ETFs can be of great help. Using industry ETFs that correspond to the sector(s) that are more likely to do well in the next 6 to 12 months might offer better returns. This sector rotation takes advantage of the economic cycles by investing in the sectors that are rising and avoiding the ones that are falling.
Sector rotation is a blend of active management and long-term investing. Active in that investors need to do some homework to select the sectors they expect to perform well. Long-term in that you can hold some sectors for years.
Investors might consider three sector rotation strategies for their portfolios. The most well known strategy follows the normal economic cycle. The other two strategies either follow the calendar or pursue a geographic strategy.
Sam Stovall of Standard& Poor’s describes a sector rotation strategy that assumes the economy follows a well-defined economic cycle as defined by the National Bureau of Economic Research (NBER). His theory asserts that different industry sectors perform better at various stages of the economic cycle. The nine Standard & Poor’s sectors are matched to each stage of the business cycle. Each sector follows their cycle as dictated by the stage of the economy. Investors should buy into the next sector that is about to experience a move up. When a sector reaches the peak of their move as defined the economic cycle, they should sell the ETF sector. Using this strategy an investor may be invested in several different sectors at the same time as they rotate from one sector to another as directed by the stage of the economic cycle.
Unfortunately the economy does not follow a well defined economic cycle, as economists cannot always agree on the trend of the economy. Making your investment decisions in mechanical like fashion following the stage of the business cycle might lead to losses, rather than gains.
The Christmas holiday often provides retailers with additional sales opportunities. The mid summer period before students go back to school often creates additional sales opportunities for retailers. People in the Northern Hemisphere tend to drive their cars more during the summer months. This increases the demand for gasoline and diesel creating opportunities for the refiners.
These events are all example of a calendar strategy takes advantage of sectors that tend to do well during certain times of the year. For example, industries that depend on the changes in the seasons such as winter vacations present another calendar opportunity for investors.
In a global economy, there are many investors who seek to enhance their returns by investing in countries or geographies that are expected to grow faster than average. This growth could come from the demand for the products or services these countries offer. Alternatively, the country or region might be experiencing unusually rapid economic growth that is expected to last for several years.
By taking a geographic strategy, an investor could beat the market by overweighting in ETFs that focus on the country or the region. The ETF helps to spread the risk of investing in specific companies in the country, something more difficult for many individual investors to accomplish.
While ETFs can help investors create a more diversified portfolio, they can also create inadvertent risk by concentrating to heavily in one sector. By investing in several different sectors at the same time, weighted according to your expectations of future performance, you can create a more diversified portfolio that helps to reduce the risk of being wrong in any one investment. In addition, this strategy can spread stock selection risk across all companies in the ETF. Investors should be careful they do not create unwanted concentration in any one sector, especially when using a blend of the economic cycle, calendar and geographic strategies.
With so many ETFs available, it is important to understand the investing strategy and portfolio makeup of the ETF before committing capital. Moreover, lightly traded ETFs pose additional risk in that it may be difficult to sell quickly if there is no underlying bid for the shares.
Sector ETFs may allow an investor to take advantage of the higher than average performance of one or more sectors in the near future. A portfolio that fully invests in a diversified set of ETFs concentrated in sectors that should outperform the market, has the potential to generate above average returns and beat the market. Such a strategy can reduce the risk of losses due to exposure to high risk stocks. Moreover, by selling a portion of your holding in sectors that are at their peak of their cycle and reinvesting in those sectors that are expected to perform well in the next few months, you are following a disciplined investment strategy.
If you are learning to invest consider a sector rotation strategy that uses ETFs to provide investors an optimal way to enhance the performance of their portfolio that can increase diversification and performance. Just be sure to assess the risks before making a commitment of your money.