Over the past couple of weeks we have mentioned the international equity sector gaining momentum and potential portfolio changes as a result. This idea of making portfolio changes based on the change in leadership or ranking is all part of a strategy we utilize called Sector Rotation.
Sectors are specific sub-categories of a market. For example, the broad stock market can be broken down into 10 sectors such as technology, utilities, healthcare etc. . If you look at the returns for each sector over time you notice that the returns can be dramatically different from sector to sector; often having as much as an 80% difference between the top and the bottom year to year. Here is a link to Morningstar’s Sector Returns page.
The term Sector Rotation strategy in non-market-jargon could simply be “category change” strategy. By ranking the various sectors (or categories) in any given market and monitoring it over time, you can clearly see those that are the leaders, those that are rising and those that are falling. By employing Sector Rotation strategy we can own more of the categories that are performing well and less of those performing poorly. As the leadership changes we look to replace the categories that are falling in ranking with ones that are rising.
The theory is not too complex. Having the time, expertise and data to put it into practice is a bit more involved and not something the average investor is likely to engage on their own. As portfolio managers, employing strategies such as sector rotation is a big part of what we do for our clients.
Here are links to Investopedia’s definition of Sector Rotation.