Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Reverse REPO Market Brewing Financial Crisis Black Swan Danger - 29th Jul 21
Next Time You See "4 Times as Many Stock Market Bulls as There Are Bears," Remember This - 29th Jul 21
USDX: More Sideways Trading Ahead? - 29th Jul 21
WEALTH INEQUALITY WASN'T BY HAPPENSTANCE! - 29th Jul 21
Waiting On Silver - 29th Jul 21
Showdown: Paper vs. Physical Markets - 29th Jul 21
New set of Priorities needed for Unstoppable Global Warming - 29th Jul 21
The US Dollar is the Driver of the Gold & Silver Sectors - 28th Jul 21
Fed: Murderer of Markets and the Middle Class - 28th Jul 21
Gold And Silver – Which Will Have An Explosive Price Rally And Which Will Have A Sustained One? - 28th Jul 21
I Guess The Stock Market Does Not Fear Covid - So Should You? - 28th Jul 21
Eight Do’s and Don’ts For Options Traders - 28th Jul 21
Chasing Value in Unloved by Markets Small Cap Biotech Stocks for the Long-run - 27th Jul 21
Inflation Pressures Persist Despite Biden Propaganda - 27th Jul 21
Gold Investors Wavering - 27th Jul 21
Bogdance - How Binance Scams Futures Traders With Fake Bitcoin Prices to Run Limits and Margin Calls - 27th Jul 21
SPX Going for the Major Stock Market Top? - 27th Jul 21
What Is HND and How It Will Help Your Career Growth? - 27th Jul 21
5 Mobile Apps Day Traders Should Know About - 27th Jul 21
Global Stock Market Investing: Here's the Message of Consumer "Overconfidence" - 25th Jul 21
Gold’s Behavior in Various Parallel Inflation Universes - 25th Jul 21
Indian Delta Variant INFECTED! How infectious, Deadly, Do Vaccines Work? Avoid the PCR Test? - 25th Jul 21
Bitcoin Stock to Flow Model to Infinity and Beyond Price Forecasts - 25th Jul 21
Bitcoin Black Swan - GOOGLE! - 24th Jul 21
Stock Market Stalling Signs? Taking a Look Under the Hood of US Equities - 24th Jul 21
Biden’s Dangerous Inflation Denials - 24th Jul 21
How does CFD trading work - 24th Jul 21
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Stock Market Sector Equal Weight Investing Strategies

InvestorEducation / Learning to Invest Dec 02, 2009 - 10:13 AM GMT

By: Hans_Wagner

InvestorEducation

Best Financial Markets Analysis ArticleMany successful investors follow sector investing. Some of the largest funds and ETFs including the SPDR S&P 500 Index ETF (SPY) base their portfolio allocation on the capitalization weighted S&P 500 index. This sector investing strategy allows you to match the market as defined by the S&P 500. Another sector investing method is to weight each sector equally.


Select Sector SPDRs

The Standard & Poor’s Select Sector SPDRs provides a good perspective into the performance of each sector within the market. The Select Sector SPDRs divides the S&P 500 into nine separate sectors. Each Select Sector SPDR tracks a specific industry index. Each sector’s portfolio is comprised of shares of companies from the S&P 500. Each stock in the S&P 500 is assigned to only one Select Sector Index. The combined companies of the nine Select Sector Indexes represent all of the companies in the S&P 500.

Breaking the S&P 500 into sectors allows you to tailor asset allocations to fit your investment goals. Owning one sector gives you more exposure to industries that may be outperforming the market. They also allow you to hedge other holdings in your portfolio. An individual sector may carry a higher risk level than the S&P 500 as a whole due to concentration on one industry. Owing a sector that is beating the market offers you an opportunity to generate returns greater than S&P 500 Index. When you select and weight the sectors that meet your specific investment goals, you can create a portfolio that meets your perspective of the market and your individual risk assessment.

The table below is from Select SPDRs site displaying the ten-year returns from sector investing. Notice how each year the performance of each sector varies significantly. In fact, as noted in the chart, “the average difference between the best performing and worst performing sectors has been more than 40% per year. For example, during the height of the dotcom boom, Technology returned 66.69% while Consumer Staples lost 14.49%. In 2000, Consumer Staples delivered 26.04% return and Technology lost 42.04%. If you were on the right side of these sectors during these two years, you did quite well. On the other hand, if you were on the wrong side your portfolio took a significant hit.

Equal Weight Sector Strategy

While there are many sector investing strategies, today we are examining one that equally weights the S&P 500 sectors. If you look at the chart above you will see a “sector” called Equal Weight. The idea is to invest in each sector in equal proportions across the nine sectors. Each sector is weighted 11.1% and rebalancing of the sectors takes place once a quarter. This approach gives you exposure to all the sectors equally. This means you experience the rallies and the pullbacks of each sector equally.

According to Standard & Poor’s the equal weighting strategy has lower volatility than the S&P 500. Over the last tens years, volatility using its standard deviation was 15.4% for the Equal Sector Strategy vs. 15.8% for the S&P 500. The more volatile sectors such as the financial and technology are more heavily weighted within the S&P 500. On the other hand, the S&P 500 under-weights the lower volatility sectors such as consumer staples and utilities. By investing equal amounts in each sector, you are skewing your portfolio toward the lower volatility sectors. This results in less volatility than the S&P 500.

Moreover, over the last ten years the Equal Weight Strategy beat the S&P 500. Had you invested in the S&P 500 ten years ago, your return would have been -0.15%, where as the Equally Weight Sector Strategy delivered 2.83% over the same ten-year period. As of the end of September 2009, the Materials sector S&P SPDR (XLB) has climbed 38.65 percent, while the S&P 500 returned 19.26%. Yet Materials is the smallest sector, comprising only 3.57% by capitalization.

This means if you owned the S&P 500 ETF (SPY) you would have not benefited from the strength in the Materials sector, as it was substantially underweighted. On the other hand had you owned an equal weight of the S&P 500, your portfolio performance would have been higher as the Materials sector would have counted for just as much as Energy sector, one of the largest sectors as measured by capitalization. The Energy sector underperformed the S&P 500. The quarterly re-weighting has both pluses and minuses. On the positive side, rebalancing the sectors captures profit from the industry groups that have outperformed the S&P and puts the money into the sectors that have underperformed the market index. You are counting on the rebound of the poor performing sectors while taking profit from the best performing industries. One of the negative’s of the equal weight strategy, is each time you reallocate your portfolio you must make nine trades to bring each sector back to their 11.1% equal weighting, incurring trading costs. These trades also incur tax consequences, negating some of the advantages of owning an ETF.

For those interested, the Rydex Equal Weighted S&P 500 ETF (RSP) follows S&P's Equal Weight strategy.

Before rushing to switch from the SPY to RSP, investors should be mindful of several risks:

  • The factors that led to the equal weight method to outperform the capitalization weight approach may not continue into the future.
  • Should large-cap stocks outperform smaller stocks; the cap-weighted strategy will do better than an equal-weight strategy.
  • Equal-weighted indexes have higher turnover and therefore higher trading costs and lower tax efficiency than cap-weighted indexes.

The Bottom Line

A sector investing strategy that equally weights each sector has provided investors with a way to beat the market by taking advantage of the lower volatility that is inherent in the method. It also encourages investors to capture profits by rotating profits from the best performing sectors to the worse performing ones. This can work out to an investor’s advantage, as each year different sectors tend to be the best performers. Be sure to understand the risks.

If you wish to learn more on evaluating the market cycles, I suggest you read:

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.

Unexpected Returns: Understanding Secular Stock Market Cycles by Ed Easterling.  One of the best, easy-to-read, study of stock market cycles of which I know.

The Disciplined Trader: Developing Winning Attitudes by Mark Douglas.  Controlling ones attitudes and emotions are crucial if you are to be a successful trader.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2009 Hans Wagner

Hans Wagner Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in