Sector Rotation Investing is a strategy used by many market professionals to beat the market. Stocks in a given sector usually have very high correlations. Instead of focusing on thousands of different stocks, some fund managers focus on the business cycle and predict its direction. Then they invest in those sectors that historically performed better in that phase of the business cycle.
One of our readers asked us to analyze FUNDX Upgrader Fund’s (FUNDX) return. FUNDX has a top-rated newsletter that utilizes sector rotation to recommend investments in ETFs and mutual funds that track those industries and sectors. One can either follow the newsletter and invest accordingly or they can simply buy the FUNDX Upgrader Fund. FUNDX has $350 million under management, annual turnover of more than 200%, and an expense ratio of 1.52%. Since the strategy tries to time the sectors, it’s expected to have high turnover and relatively high expenses.
Insider Monkey, your source for free insider trading data, downloaded FUNDX returns from Yahoo! Finance for the past 8 years. We used Carhart’s four factor model to calculate alpha and betas. Our regression results show that FUNDX has a monthly alpha of negative 14 basis points after expenses since July 2002. This implies that the way FUNDX executes its sector rotation strategy doesn’t even generate alpha before expenses. Since its investors have to foot the bill for expenses, they lost more than 1.5 percentage points a year by investing in FUNDX.
We also calculated FUNDX’s alpha since the beginning of 2006. This is a great period to stress test an investment strategy because of the enormous volatility and dislocations in the market. Unfortunately, FUNDX performed even worse since 2006. FUNDX’s monthly alpha was NEGATIVE 28 basis points per month. This is a loss of more than 3 percentage points per year compared to other low cost investment strategies. FUNDX didn’t favor small or large cap stocks, and it was neutral towards value or growth stocks. It had a moderately positive momentum beta, meaning it was chasing hot stocks/sectors as it said it would.
Finally, our graph suggests that FUNDX pretty much stopped sector rotation and went with index hugging since the collapse of Lehman Brothers. However, our regression results still show large negative alpha for the past two years as well.