Sector Rotation: Can the Approach Work in Different Countries?
Research on sector rotation, which is a popular tactical asset allocation technique, often centres on using price momentum as the sole criterion to identify outperforming sectors. In this paper, we examine the viability of implementing a sector rotation strategy using a blend of parameters. These include macroeconomic indicators and fundamental information, in addition to price momentum. Our aim here is to give investors ideas on implementing a tactical sector rotation strategy systematically using sector ETF building blocks.
For our research, the selection approach was simulated across different geographies (namely the US, Europe and World developed markets) and rebalanced at the end of every month. We call this approach the Sector Selection Research Model.
Results show that the sector rotation strategy beat its respective benchmarks across all regions over the entire period, and with diminished volatility. The tactical nature of the allocation means that the portfolio turnover, which is a major driver of transaction costs, was remarkably high (~200%). Even so, the outperformance of the simulated sector rotation strategies remained robust after including estimated transaction costs. This suggests there may be merit in combining multiple criteria to select the most attractive sectors.
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