I've been thinking for a while now about taking some money and putting it into the top 5 sector funds, perhaps Fidelity. Then, by following the funds figure out whether to switch some of the investment from one sector into another.
Are there any well-known or highly approved techniques for deciding which sector fund(s) to rotate out of and in to, or whether this is a viable plan at all?
I'd appreciate comments from some of you that may have had experience with either studying investment techniques or actually trying a sector rotation scheme.
Forget it. There are probably many algorithms for deciding which sector is going to be the next hot one or cold one, and they are all witchcraft. Some of the best and most mercenary professionals in the world play this game. It is a special case of what all fund managers do, and which 85% of them fail to perform as well as the SP500 over any appreciable period. The absolutely brilliant and lucky money beats the market, and doesn't do it with simple published rotation schemes.
85% of the merely smart professional money does worse than SPY, but self-acknowledged dumb money (like mine) does perform in line with the market by being invested mostly in a simple SP500 or wilshire 5000 index fund, and thereby becomes not so dumb. Joe Weinstein
Gary, What do you mean by "top 5"? Why 5? Would you put the same amount of money in each? Would you do this with all your money or 5% of it? And of course...why this strategy?
I generally agree with Joe. However, there is always the asset allocation method where each period you rebalance your portfolio, taking money from the hot sectors and putting them into the cold sectors (or just addign new money to the cold sectors). This would probably need to be done mechanically to get any benfit (i.e. don't change the timing intervals or the allocations based on market conditions). Probably not what you were looking for...
I have just started to invest in sector funds, but have done a similar thing with individual stocks, selling when the stocks are overvalued and buying a new one in the same sector so that I keep my weighting in the various sectors in line.
These are very good questions, and further reveal my intent.
I have no current meaning for the "top 5". But they would refer to the 5 sector funds that are either (1) performing well, or (2) have the greatest performance prospects by some criterion that I am not aware of as of now.
Why 5? No special reason. Not all of them, not none of them...somewhere inbetween.
Same amount in each? Don't know, except a good strategy might weight some sectors by whatever criterion, giving higher weights and therefore a higher percent of the pot. For example, a momentum model would give more weight to sectors on the rise at a faster rate.
I would not in a million years do this with all my money, just 5 or
A) Healthcare, Financial, Technology, and Consumer durables?
or
B) Biotech. Pharmaceuticals, Banks, Real Estate, Media and Telecommunications, Internet, Software, Consumer Products, Leisure products.
2) How much are you expecting to gain from this- as percent of portfolio/ relative to gains of overall portfolio?
3) When will this money be taken from the "sector pool" and added back to normal retirement income stream? Annually, every 5 years, in 15 years....?
Admittedly, the term "conservative" has different meanings to different people, but I would not think that sector rotation, as you've described it, would be considered conservative by many. This is essentially a market-timing strategy, you've even mentioned momentum components. That sounds fairly aggressive to me.
I have about 10% of my portfolio invested in Fidelity Selects and am going just what you suggest. I subscribe to a highly rated newsletter which provides a monthly ranking (based on historical performance) of many funds and I screen the top Class 1 (risky) Fidelity funds, mostly all Selects.
Gary, I echo what Will and Ron said. An extremely popular strategy is to (a) have an asset allocation plan; and (b) rebalance say once a year so as to remain consistent with the plan. For ideas on allocating, I suggest experimenting with some of the free online asset allocators linked at
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Then continue picking index funds or, in the alternative, maybe index ETFs, to achieve your desired asset allocation. Fidelity has restrictions on frequent trading of many of its mutual funds, so ETFs may be preferable. Vanguard, for one, has a persistently improving stable of index ETFs which of course you could trade within your Fidelity account. (Disclaimer: I am a 20+ year Fidelity customer, but I think Vanguard has far better mutual fund and ETF offerings. Other brokerage/ETF/mutual fund houses are increasingly competitive with both.) You are certainly on the right track by holding index funds in general. The approach above is mechanical, but this reflects the virtues a disciplined, and so successful, investor possesses. Caveat: "Chasing returns" is not the hallmark of a disciplined investor. Resist buying after a particular sector fund has risen, in the belief it will keep rising. Study the vagaries of mass markets and businesses to 'keep the faith' that investing in companies will beat inflation by a lot and preserve your investments.
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has a very good list of books, ones that are often mentioned here and so tend to be, IMO, sound recommendations. Even just skimming one or two at a time over a week or so, followed by asking questions here or at similar fora, can help your study a lot.
I'm always interested in the motivations for picking a specific strategy like this. I personally like stock-picking, using a value/contrarian approach, and it has appeal to me because I'm also the guy who takes vacations the week after Thanksgiving when the fares are cheap and the restaurants are happy to see you.
You say you're a statistician and it makes some sense that you might gravitate to something that builds on that, for example sector rotation involving technical analysis. But the question I think everyone needs to ask is whether it makes sense to deviate from that "default" portfolio of index funds. If a strategy isn't likely to leave you with more money why would you bother? This isn't for entertainment, it's for making money. If you want entertainment, play fantasy football which is also stats-intensive.
The appeal of sector rotation is that individual sectors are much more volatile than the overall market and there appears to be the opportunity for juicing returns by avoiding the lousy sectors and riding the winning ones. Or maybe it's buying the lousy sectors and avoiding the overpriced winning ones. Or something else...and there's the rub. Believe me this is a strategy that is quant-jocked to death and there are plenty of people playing it. I don't know of a winning strategy and if there was one why would you publish it? Not that I think there even could be a winning strategy, just saying.
So the question is, do you think you have any particular insights or skill into what sectors to pick (or avoid), so you'll do well at it? Rhetorical question but without an affirmative answer...again...why bother? The point of "efficient markets" and indexing is that it's very difficult to beat the market, and that securities prices reflect available information. By extension, sector valuations reflect available information, because sectors are just lists of stocks grouped by SIC code or some similar criteria. So making accurate calls would require both excellent insight into the factors that affect a given industrial sector (arguably, you'd need to know this for every sector), and good skills at predicting where these factors are heading (whether it's drug price regulation, interest rates, OPEC policy, tax policy, and on and on). Personally I don't think these things are knowable or predictable, making this a low-probability kind of strategy. YMMV.... =)
Just my opinion, but from my reading, many financial planning gurus along with serious statisticians would take offense at this! "Technical analysis" may be argued to be nothing more than applied numerology--one gets enough numbers and looks at them long enough, disregarding all rules for random distributions yada, and some pattern will seem apparent. Just like watching the clouds and seeing shapes formed by them. In TA, little to no attention is given to company fundamentals.
Correct, very much in the same way that Vegas attracts gamblers by the millions each year. Some win (and generally not regularly). Most necessarily lose.
I have most of my investment in about 5 sectors: Tech with 9 stocks, home builders with 3 stocks, energy/natural resources with 9 stocks, health with 5 stocks, and international with 1 ETF. I have my 401k in a mutual fund (< 5%).
Here I am, sitting on a fence, not quite sure whether to try this thing which is a temptation for me. I find your comments very discouraging, and maybe extremely wisely so. I guess I'll let the temptation drop until the next time it rears its ugly head.
This is from an old blue chip index fund buy-and-hold 100% stocks guy (except for dedicated savings accounts like car, vacation, emergency, next house project, etc.).
Every time I get the itch to try something different - usually fueled by a desire to chase returns - I've come to the conclusion that the best thing for me to do is to lie down until the urge passes. I only wish I could have come to that conclusion earlier.
Try running some paper portfolios for a year or so. Define and *write down* rules for each portfolio. *Write down* why you buy and sell each fund. At end of the year, review your portfolios and buy/sell decisions. Don't forget to include any commissions.
You should be able to tell whether you are adding value compared to index strategies. If you are, you might want to start playing with real money. Be aware that strategies that work one year could fail the next. That's why it's important to write down rules and trading decisions. You must know more than "this strategy worked this year". You must know why it worked.
Take a look at
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for a variety of stock and mutual fund strategies. (no sector fund strategies, however).
Well there's always trying it with play money first, just create an imaginary portfolio with $10k in it and run it for awhile. Though if you're trying to capture multi-year cycles among the sectors, you might not live long enough to have a statistically valid sample of your sector picks!
The other point is...are sectors even significant as a selection criteria, or is it as irrelevant as "companies with blue logos"? If you buy into the Chicago-school view of passive investing (Fama/French research suggesting that risk and returns are largely explained by looking at book to market value and company size) you don't even care what the industry is. Has it been more valid to group JCPenney with Wal-mart, Williams-Sonoma or A&F, or were its characteristics driven entirely by non-sector factors?
This is where I'd look at a bit a back testing. I've seen charts that break out investment choices and rank them each year. Large cap, small cap, both growth and value for each, real estate (REITS), bonds, gold, etc. No one class is in the top all the time, and even overlaying the business cycle, and having the advantage of hindsight, came to the conclusion that unless I knew with certainty when we were headed for a recession or expansion, that going forward I would not be able to choose correctly.
I suspect a similar thing will happen with sector fund analysis. You can rank each sector with hindsight, but have a tough time predicting which sector to choose moving forward. If this is done with a small portion of funds, I don't see much risk, nor much impact to one's portfolio. But if done with most of one's assets, one set of bad choices can really underperform the market. I'd like to see what the OP finds as he researches this.
Your risk isn't that high. For instance, in the last 5 years, iShares DJ US Energy (IYE) hasn't had a drop of much more than 20% in the short term while it has doubled over the period.
Looking through iShares, I think you found the one with the best return, up about 125% (plus whatever dividends) vs the S&P up about 22%. But what makes you think Gary would have chosen this sector five years ago? IXN (Technology) is barely up at all, and this sector puts out little in the way of dividends (.04%). His risk is being wrong, down, while the rest of the market is up. (Disclaimer - I am a fan of being overweighted S&P index, low cost. So over time, I am guaranteed to beat the index (the dividends exceed the expenses of the index, and the index doesn't account for dividends, so I'll beat the index, but lag the S%P total return by .05%))
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