An Easy to Implement Sector Rotation Strategy | ETF Trends

Sector rotation, the act of moving in and out of various based on economic climate or market setting, is undeniably made easier with sector exchange traded funds.

“For investors looking to take a more active approach to stock diversification—that is, beyond a broad-based index fund—a so-called sector rotation strategy is one way to go,” according to Charles Schwab research. “With this approach, you overweight or underweight various sectors in your portfolio against a benchmark weighting—say, the S&P 500® Index—based on their expected performance.”

Sounds alluring…and burdensome for many investors.

Still, properly executing sector rotation on one’s own is tricky. Even the pros get it wrong on occasion. However, sector rotation can be attained in a somewhat automated fashion with the highly popular First Trust Dorsey Wright Focus 5 ETF (NasdaqGM: FV).

The $2.72 billion FV turns eight years old next March and tracks the Dorsey Wright Focus Five Index.

That index “is designed to provide targeted exposure to five First Trust sector and industry based ETFs that Dorsey, Wright & Associates (DWA) believes offer the greatest potential to outperform the other ETFs in the selection universe and that satisfy trading volume and liquidity requirements,” according to First Trust.

That methodology is relevant in relation to sector rotation because the selection universe for ETFs eligible to be included in FV isn’t confined to dedicated sector funds. FV can also hold broad market and industry offerings.

For example, the First Trust Nasdaq-100 Tech Index (NasdaqGM: QTEC), which tracks the NASDAQ-100 Technology Sector Index, is one of FV’s current holdings, as is the First Trust Nasdaq Transportation ETF (FTXR), which is an industry fund, not a sector fund.

Still, the point is that FV makes sector rotation easier on investors because investors don’t need to do any legwork, and that legwork can be substantial. As Schwab notes, proper sector rotation includes evaluating factors such as secular trends, the economic cycle, the market cycle, and sector-specific trends.

“Once you’ve evaluated secular trends, the business and market cycles, and the sector-specific features currently at play, you can look for opportunities and compare your allocations to those of a broad-market benchmark,” according to Schwab.

Translation: Manual sector rotation for ordinary investors is labor-intensive. Conversely, FV simply employs the famed Dorsey Wright relative strength methodology to compare ETFs “to each other to determine inclusion by measuring each ETF’s price momentum relative to other ETFs in the universe.” From there, the funds are scored and the top scorers make the cut. Easy enough.

For more news, information, and strategy, visit the Nasdaq Investment Intelligence Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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