Why sector rotation investing is hot

January 22, 2014 by Covestor

Everyone knows they should rotate the tires on their car for a smoother ride, but what about your investment portfolio?

So-called sector rotation strategies that invest in mutual funds were among the top-performing portfolios in 2013, reports Mark Hulbert for MarketWatch :

“Those are the conclusions that emerge from a review of the 2013 performance rankings of the more than 500 portfolios monitored by the Hulbert Financial Digest. Of the 10 mutual fund portfolios that made the most money last year, nine focus on sector rotation.”

Interestingly, the top performers in the category did not all concentrate on the same funds and sectors.

Hulbert notes:

“This suggests that there is more than one way of playing the sector rotation game, which is good news. If there were only one profitable sector strategy, it would quickly become so overused as to stop working.”

The L2 Portfolio managed by the Rockledge Group on the Covestor platform employs a sector rotation strategy in an effort to outperform the S&P 500 (SPX ) over a multi-year timeframe.

Jim Mitchell, a partner at Rockledge, said the L2 Portfolio takes more of a longer-term view to investing than many other sector rotation strategies.

“The premise is that being in the right sectors leads to good performance,” Mitchell said.

Rather than trying to identify stocks in the S&P 500 that could potentially outperform, Rockledge tries to position among the nine major sectors of the U.S. blue-chip index, using ETFs.

The L2 Portfolio currently owns Industrial Select Sector SPDR (XLI ), Financial Select Sector SPDR (XLF ), Technology Select Sector SPDR (XLK ), Health Care Select Sector SPDR (XLV ) and Consumer Discretionary Select Sector SPDR (XLY ).

Sector-rotation strategies try to capitalize on the fact that various phases of the economic cycle tend to favor different industries.

For example, most investors are familiar with “defensive” sectors like healthcare and consumer staples that sell products that people need in any economic climate. Also, as 2013 demonstrated, utilities stocks tend to lag the market when interest rates are rising.

“The idea is to figure out which sectors have the wind at their backs and which sectors have the wind in their face,” Mitchell said.

As with all active strategies, the success of sector-rotation portfolios depends on the skill and approach of the managers.

Other portfolios on the Covestor platform that use ETFs to time sectors include Sector Rotation Portfolio managed by Island Light Capital, and Dynamic Factor Portfolio managed by Julex Capital Management.

Photo Credit: saul.grinberg

DISCLAIMER: The investments discussed are held in client accounts as of December 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.