Long-term exchange traded fund investors should take the time to evaluate market conditions to tap into potential opportunities and diminish rising risks.
“To build a better equity portfolio, it pays to think cyclically, and to revisit sector investing,” write Archan Basu, senior vice president of portfolio construction guidance at Fidelity Financial Advisor Solutions, and Dirk Hofschire, senior vice president of asset allocation research with Fidelity Investments’ asset management division, for InvestmentNews.
The strategists point out that each sector exhibits a unique pattern of earnings growth and decline as the markets moved through peaks and troughs throughout economic cycles.
Using market data as of December 2013, Fidelity has found that sectors have historically displayed three distinct characteristics: Sectors show fairly stable compositions and have consistent classifications. Sectors have clear patterns for volatility. Lastly, sectors are not perfectly correlated, which provides performance dispersion between various areas of the market.
“This generates attractive diversification potential, which provides you with an opportunity to add value to your clients’ portfolios, even if it doesn’t guarantee against a loss,” Fidelity said.
When considering the time frame for the investments, these types of cyclical sector plays also fall in between strategic long-term and tactical short-term time horizons and tolerance for risk.
“A cyclical and sector position should weather a wide range of potential economic scenarios over an intermediate time horizon, often over two or three years,” the strategists added.
Currently, we are in a mid-cycle expansionary phase. Consequently, investors can expect sustained relative earnings growth in the technology and industrial sectors, according to the Fidelity strategists.
Year-to-date, the Technology Select Sector SPDR (NYSEArca: XLK) rose 2.5% and Fidelity MSCI Information Technology Index ETF (NYSEArca: FTEC) gained 3.2%. Meanwhile, the Industrial Select Sector SPDR (NYSEArca: XLI) was up 0.5% and Fidelity MSCI Industrials Index ETF (NYSEArca: FIDU) was 2.3% higher. [Investors Flock to Cyclical Sector ETFs]
Looking ahead, Fidelity also argues that investors could add some exposure to late-cycle industries, including energy and materials.
Year-to-date, the Energy Select Sector SPDR (NYSEArca: XLE) returned 5.2% and Fidelity MSCI Energy Index ETF (NYSEArca: FENY) increased 4.8%. Moreover, the Materials Select Sector SPDR (NYSEArca: XLB) added 3.7% and Fidelity MSCI Materials Index ETF (NYSEArca: FMAT) rose 3.6%.
For more information on market sectors, visit our sector ETFs category.
Max Chen contributed to this article.