What Is a Sector Rotation?

Sector rotation is the action of shifting investment assets from one sector of the economy to another. Sector rotation involves using the proceeds from the sale of securities related to a particular investment sector for the purchase of securities in another sector. This strategy is used as a method for capturing returns from market cycles and diversifying holdings over a specified holding period.

Understanding a Sector Rotation

Individuals or portfolio managers may deploy a sector rotation strategy. Sector rotation requires a great deal of liquidity and broad latitude for enacting investments positions. If broad trading flexibility is available, then sector rotation can be a viable way to position investment portfolios to take advantage of market cycles and trends providing for capital appreciation potential in particular areas of the investment universe.

Sector rotation seeks to capitalize on the theory that not all sectors of the economy perform well at the same time. Managers using sector rotation strategies aim to rotate investment capital to sectors they identify as offering profitable investing opportunities. In-depth research on the economy and data from the National Bureau of Economic Research (NBER) helps to support sector rotation investing. Other types of sector rotation investing may center around seasonal or yearly trends with data supporting advantages to rotating in and out of different profitable categories throughout the year.

Broadly, research on market cycles forms the basis of investment theory around sector rotation investing. Broad market sector rotation investing seeks to follow market cycles of the economy. These cycles can be characterized in various ways but are usually associated with bullish and bearish outlooks as well as recessions, recoveries, expansions, and contractions.

Sector rotation strategies following economic market cycles often seek to identify bullish sector opportunities in expanding markets and mitigate losses through sector rotation to safe havens in recessionary markets. In a sense, sector rotation is a concept that most active portfolio managers keep in mind when considering all types of investments. However, implementing sector rotation strategies with significant market depth requires comprehensive foresight and access to in-depth market research for success.

Professionally managed sector rotation funds can be a good investment because they seek to maintain positions in the most profitable areas of the market at all stages of an economy’s economic cycle. Exchange-trade funds (ETFs) are notably simple to execute through sector rotation, making this a great strategy for beginning investors.

Limitations of Sector Rotation

Sector rotation strategies can be expensive to implement because of the potential costs associated with extensive market trading, which can negatively affect returns. Moving capital in and out of sectors can be costly due to trading fees and commissions. For that reason, sector rotation is typically a strategy considered for institutional managers or high net worth investors.

Sector rotation also requires very active analysis of investments and economic data. It is typically a consideration for professional portfolio managers because of the time constraints and data access involved.

Sector Rotation Investment Funds

Sector rotation investment funds are not broadly offered for retail investors in the investment universe. Fidelity manages one fund, the Sector Rotation Fund, which is now closed to new investors. The Fund was launched in December 2009 and reports an annual return of 9.04% since inception. The Fund invests across multiple asset classes. It uses a fund of funds strategy with ETFs invested across market sectors. Weightings of market sectors are adjusted based on sector rotation views.

Several institutional investment managers also offer sector rotation investing strategies. These managers typically use a fund of funds strategy to obtain market exposure. Institutional investment managers offer sector rotation funds based on the sectors of a single economy, or they may also use sector rotation to develop a portfolio of investments across individual countries.