Sector, Factor ETF Strategies to Capitalize on a Changing Market Environment

As the economy moves towards the late business cycle, with shifting fiscal and monetary policies, exchange traded fund investors should consider targeted strategies to capitalize on the changes ahead.

On the recent webcast, Finding Strategic and Cyclical Exposure: Sector and Factor Investing, Denise Chisholm, Sector Strategist at Fidelity Investments, pointed out traders have been facing a market of earnings growth contractions. However, investors can still find areas of opportunities.

For example, consumer staples and the health care sectors have historically stood out and outperformed, generating alpha when earnings growth was decelerating. In contrast, in periods when earnings growth was decelerating, the technology and industrials sectors underperformed.

While we have seen slowing earnings growth, the markets may turn around if the Donald Trump administration enacts a number of promised reforms like tax cuts and deregulation. Chisholm showed that markets enjoyed corporate profit acceleration and growth during periods of corporate tax cuts. However, the strategist warned that defensive sectors typically underperformed cyclical sectors during periods of lower corporate tax rates.

When profits begin to rise, Chisholm also singled out REITs, Technology and Energy as outperforming sectors in periods of earnings growth acceleration. In contrast, utilities, telecommunications and consumer staples sectors underperfomed when growth is accelerating.

These sector by sector plays may become increasingly important as we head toward a rising rate environment. Chisholm mentioned that the odds of profit acceleration has been 58% when rates rise, whereas the odds of profit acceleration has been 36% when rates drop.

ETF investors interested in gaining exposure to individual sectors or execute a sector rotation strategy have a number of options available. For instance, Fidelity’s sector ETFs include:

  • Fidelity MSCI Consumer Discretionary Index (NYSEArca: FDIS)
  • Fidelity MSCI Consumer Staples Index ETF (NYSEArca: FSTA)
  • Fidelity MSCI Energy Index ETF (NYSEArca: FENY)
  • Fidelity MSCI Financials Index ETF (NYSEArca: FNCL)
  • Fidelity MSCI Health Care Index ETF (NYSEArca: FHLC)
  • Fidelity MSCI Industrials Index ETF (NYSEArca: FIDU)
  • Fidelity MSCI Information Technology Index ETF (NYSEArca: FTEC)
  • Fidelity MSCI Materials Index ETF (NYSEArca: FMAT)
  • Fidelity MSCI Telecommunication Services Index ETF (NYSEArca: FCOM)
  • Fidelity MSCI Utilities Index ETF (NYSEArca: FUTY)
  • Fidelity MSCI Real Estate Index ETF (NYSEArca: FREL)

Alternatively, Darby Nielson, Managing Director of Research at Fidelity Investments, argued that investors can turn to factor-based investment strategies and ETFs as a way to better manage risks and capture market moves. The factor-based ETFs may help investors “seek out factor exposures for return/outcome potential and risk management,” Nielson said.

For example, investors can look to Fidelity’s line of factor based ETFs, including:

– Fidelity Dividend ETF for Rising Rates (NYSEArca: FDRR)

Fidelity Low Volatility Factor ETF (NYSEArca: FDLO)

Fidelity Momentum Factor ETF (NYSEArca: FDMO)

Fidelity Quality Factor ETF (NYSEArca: FQAL)

Fidelity Value Factor ETF (NYSEArca: FVAL)

Fidelity Core Dividend ETF (NYSEArca: FDVV).

“Fidelity has a long history of factor investing, which has evolved significantly over the last decade since the Quantitative Reasearch team was formed,” Nielson said.

The line of Fidelity factor based ETFs can help investors achieve strategic and cyclical exposure, along with filling out an investment portfolio construction. By incorporating the various factor based ETFs into an investment portfolio, investors may be better able to diminish risks and still capture any upside potential.

“Most factors are not highly correlated, so diversifying among them may improve risk-adjusted returns over time,” Nielson added. “Diversifying across multiple factors can help investors achieve more consistent performance over time.”

Financial advisors who are interested in learning more about cyclical investment strategies can watch the webcast here on demand.

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