Newsletter. “If you’re holding six or seven industries, that’s a fair amount of diversification,” Subramanian says. “Don’t do just two or three groups.”
Sector investing should be viewed as a complement to your core portfolio offerings of more diversified funds. Education and guidance are readily available; for instance, if you click on the “Stocks” tab on Morningstar.com, you’ll find a link to obtain stock performance data by industry or by sector. You can obtain return figures for various time periods going back the last five years. The myriad features at Yahoo Finance’s stock research center (http://biz.yahoo.com/r/) include a tool that sorts sectors according to a variety of factors, including market capitalization, dividend yield, and P/E ratio.
THE FUND ROUTE
You can take easier routes into sector rotation-thanks to an increasing number of mutual funds and exchange-traded funds that provide exposure to specific sectors. For instance, Fidelity Investments offers 41 select funds which focus on sectors as broad as consumer staples and as specialized as air transportation. ProFunds, Rydex, T. Rowe Price, and Vanguard are also known for sector funds. And exchange-traded funds-mutual funds that can be traded like stocks and often group companies of the same industry-are an increasingly popular way to invest in sectors.
Sector ETFs, including Barclays Global Investors’ iShares and State Street Global Advisors’ SPDRs, are popular because they can be bought and traded quickly in response to market changes-without the redemption fee that many mutual funds charge. What’s more, sector ETFs do not require minimum investments. But it’s possible to build a diversified portfolio of ETFs with as little as $6,000, says Subramanian, adding that having at least $1,000 in each fund helps mitigate the sting of brokerage fees.
There are still simpler ways to play the rotation game: Use single funds that do the work for you, such as the Claymore/Zacks Sector Rotation ETF (XRO) or Rydex Sector Rotation C (RYISX). The Rydex mutual fund ranks 67 industries according to price momentum, and invests in those that are top ranked. As of mid-March, the fund posted a 5-year average annualized return of 14.1%, earning it a spot in the top 10% of Morningstar’s large-blend fund category. “It’s for buy-and-hold investors who believe in sector rotation but don’t have the time or expertise to evaluate market trends at the industry level,” says Rydex portfolio manager Adrian Bachman, whose firm also offers 18 individual sector funds.
Bachman is the first to admit that sector rotation funds are somewhat more volatile than the market overall, because of the nature of sector investing. Many investors use it as the third leg of an investment stool that includes growth and value components, having it account for no more than 20% to 30% of equity portfolios.
Sector investing has its drawbacks. Unlike the buy-and-hold approach, it requires frequent buying and selling, which means additional brokerage fees and a bigger capital gains tax hit. Rydex Sector Rotation, for example, trades out of one industry and into another as much as four times a month, according to Bachman. Of