Etfs: The 2.0 Version of Sector Rotation: by Hafeez Esmail. February 10, 2015
Etfs: The 2.0 Version of Sector Rotation: by Hafeez Esmail. February 10, 2015
Etfs: The 2.0 Version of Sector Rotation: by Hafeez Esmail. February 10, 2015
Allocation Choices
There are different approaches to try to outperform the benchmark. Firms using fundamental
analysissuch as my firm, Main Management LLCseek to pinpoint undervalued
sectors/subsectors and seek out a catalyst that should propel that sector to revert to its mean. We
express these findings by overweighting favored sectors. That said, you can also eliminate
unfavorable sectors. As an example, Main Managements U.S. Equity Sector Rotation Strategy
opted not to own any energy exposure in 2014. It was one factor that allowed the strategy to be
among the 20 percent of active managers that beat their benchmark in 2014.
The other well-known approach to sector rotation is tactical management. These are firms that
use either technical or proprietary signals to rapidly move in and out of sectors, and potentially
move out of the market altogether. Some of these approaches have been highly successful during
certain periods (including the 2008-09 recession), but many of those have had less-thanfavorable outcomes where there has been no downturn. While tactical approaches may have their
merits, being tax-aware is typically not one of them. While a fundamental manager generally has
more judicious turnover, this can have appealing outcome on an after-fee, after-tax basis. The
rapid signal changes of tactical models tend to generate predominantly short-term gains and
losses from a tax perspective.
In summary, its important to recognize that sector rotation has evolved from its single-stock
world to a generally more efficientand, one may argue, more effectivemodel when
implementing an investment outlook using ETFs. A fundamental manager, in general, may
outperform or underperform the benchmark, but typically it will not be by significant margins,
but may be more consistent. Tactical models may have more dispersion in their outcomes, where
results may vary from feast to famine.
Which one is best for a given client? The answer may lie in whether one is seeking a more
uniform core portfolio (relative to a benchmark) or one is seeking greater potential upside but is
willing to accept greater deviation from a given benchmarkboth favorable and unfavorable. A
fundamental manager may be better suited to the former, and a tactical approach to the latter.