We first use a fundamental approach to identify sectors of the U.S. and international economies which likely have a significant advantage or disadvantage in the current environment. Simply eliminating unfavorable sectors and diversifying among the rest is usually a better strategy than simply investing in the index(es). The beauty of the approach is being wrong may result in lost opportunity but not in a loss of money. But very often, identifying an unfavorable sector is fairly obvious, with a high probability of being correct. Such as, if mortgage rates jumped to 12%, eliminating homebuilders and mortgage companies from the portfolio, while diversifying in the remainder of the market, would likely result in a higher return than investing in the entire market. There are many examples, sometimes due to interest rate changes, new taxes, government regulations, or other market conditions.
It is important to understand that Sector Rotation is not possible when managing hundreds of billions or trillions of dollars. That is most certainly why large Broker/Dealers do not talk of it – they simply manage too much money to sell out of a sector or to overweight one which may be favored in the current environment.
Another advantage we have over the broad indexes (such as the S&P 500), is that we use a similarly weighted approach. For example, if we liked Apple and Southwest Airlines, out of $10,000, we might allocate about $5,000 to each. The index would allocate over $9,400 to Apple and less than $400 to Southwest, making Southwest near meaningless to your portfolio. Equal weighting and earnings-weighted portfolios have generated higher returns than the traditional cap-weighted indexes over the last one, three, and five years. Also, in all three periods the Sharpe Ratios (risk adjusted returns) were higher too. Hence, the higher returns were achieved with lower volatility.