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Sector rotation techniques have been around for decades, a relatively simple strategy often used by investors seeking to capitalize on short-term mispricings in order to generate alpha. In its most basic form, sector rotation involves segmenting the equity universe by industry, and moving into and out of various sectors depending on relative attractiveness from a valuation perspective. The idea is to overweight the sectors that are attractively priced, and underweight those that are deemed to be overvalued. Those who are able to identify overbought and oversold sectors–or even broader trends that may favor high beta or low beta stocks–can beat the market by regularly shifting exposure [see also Nine Twists On Sector ETF Investing] .

More recently, ETFs have become popular tools for investors implementing sector rotation strategies; instead of requiring investors to identify individual stocks with promising outlooks, a high level approach can be employed to achieve broad exposure to a number of industries with a single ticker. And innovation in the ETF industry has allowed for enhanced granularity; sector-specific ETFs no longer include the nine primary industries, but sub-sectors such as medical devices. gaming. fishing. and airlines .

The suite of sector SPDRs are generally the most popular tools for investors looking to implement a short-term tactical tilt towards or away from a certain sector, and the trading volumes on these funds illustrate the appeal to investors with a limited holding period. The Energy SPDR (XLE ), for example, has an average daily volume of 19.5 million shares–about 15% of the total shares outstanding (implying an average holding period of 6.5 days). But thanks to the innovation in the ETF industry, there are now numerous options available for investors looking to achieve targeted exposure to a specific sector of the economy. PowerShares offers a suite of small cap sector ETFs, while iShares has debuted a number of ex-U.S. sector funds. And the evidence suggests that these various versions of sector ETFs offer very unique risk/return profiles.

So investors looking to implement sector rotation strategies have numerous options available to them, including targeting exposure by market capitalization and geography. Picking sectors to overweight or underweight is only the beginning of strategy implementation; sector rotators must then decide which of the numerous tools to use to express their view. And as shown below, that choice can have a major impact on bottom line returns [see For ETF Investors, The Details Matter ].

Consumer Discretionary

The following table shows the year-to-date performance of three Consumer Discretionary ETFs through May 2011: