Portfolio 4: Industry Momentum Trading Strategy
Posted by Vijay Singal on July 20, 2008
Fourth portfolio:
The Industry Momentum Trading Strategy takes advantage of the fact that well performing industry sectors tend to continue to perform better than the market in the near term. A complete description of the strategy is given in other columns of this blog. A brief description of the strategy is given after the portfolio.
The entry date for this portfolio is July 21, 2008; and the exit date is August 25, 2008.
If investment limitations can support at most 3 funds in any industry, exclude FSCSX, FBIOX, and FPHAX.
Industry Momentum Trading Strategy:
Industry momentum refers to a phenomenon where industries that have done well in one period also do well in the next period. This pattern in returns has been documented and verified through extensive research by practitioners and academics over the last several decades.
I use Fidelity Sector funds for the trading strategy because they are single-industry mutual funds designed to capture industry movements with a few stocks. The advantage of Fidelity Sector funds over homemade industry portfolios is that the cost of trading and maintaining a portfolio of Fidelity Sector funds is relatively small. Trading among Fidelity sector funds can be costless if the portfolio is held for at least thirty days and traded via the Fidelity website. The short-term trading fee is 0.75 percent if the fund is held for less than thirty days.
Trading strategy set up:
There are 43 Fidelity sector funds in 21 unique industries. Fidelity has 5 funds in health care: medical delivery, medical equipment, pharmaceuticals, biotech, and health care. I consider all of them in the same industry. On the other hand, there is a separate sector fund for gold, also an industry; for leisure, also an industry. When multiple sector funds constitute an industry, the amount to be invested is equally divided among the sectors.
Trading Strategy Implementation:
I intend to create a portfolio every weekend, which will be announced by morning of the first trading day of the week (usually Monday morning) so that funds can be bought at the close of the first trading day. Portfolio 1 is being announced this weekend (for trading on May 27th). Portfolio 2 will be announced for trading on June 2, portfolio 3 for trading on June 9, portfolio 4 for trading on June 16, and portfolio 5 for trading on June 23.
Since the holding period is 5 weeks, portfolio 1 will be reconstituted on June 30. Sector funds no longer in the new portfolio will be sold and exchanged for sector funds that need to be added to the portfolio. At that time, performance relative to other benchmarks will also be reported.
Though the strategy is designed for an investor in only one portfolio, you may participate in all 5 portfolios as a way of further diversification.
Taxes:
Note that this trading strategy relies on short-term trading. When compared with a buy and hold strategy, industry momentum will result in higher taxes. You can reduce your tax liability by trading in a tax-deferred account. In any case, it is important for you to compute your after-tax returns to determine whether or not the extra returns are sufficient to overcome the extra taxes.
Past Performance:
The annual return of this strategy for an 18-year period, from 1990 to 2007, is 16.79% compared with 12.28% for the S&P 500. The sector rotation strategy outperforms the S&P 500 by approximately 4.5% a year, on average. An investment of $100,000 grows to $660,000 with a buy and hold strategy and to $1,380,000 with sector rotation. Neither strategy considers tax liability.
The risk of the sector rotation strategy is marginally lower than the risk of S&P 500. The strategy outperforms the S&P 500 in 12 years out of 18 years. Of course, past performance is not necessarily a good indicator about future performance.
Anne Clelland said
Today’s the exit date! I’d be eager to hear what happens!
If it interests you to appearl to a general audience, would you be open to answering a few questions, answers to which might interest the readers of Handshake 2.0?
If so:
Is Beyond the Random Walk for experts or can the general population benefit from some of your findings? If so, what would be the layman’s “takeaways” from your book?
What is a layman’s description of what you are trying to do in your blog?
Thanks!
Vijay Singal said
Anne:
I compute the returns about once a month because the calculations are quite time consuming. I hope to report the returns in the very near future.
My book, Beyond the Random Walk, is designed for the ordinary investor, but not for someone who has never traded before. Experts can also learn from reading the book. The book has several strategies where you can do better than the market because the price movements are predictable. For example, a positive earnings announcement is usually followed by positive returns over the next several days. More details are in the book.
My blog targets the same kind of person and shows the actual implementation of one strategy in my book.
Vijay