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Trying Equal Sector for domestic allocation
Old 01-15-2017, 09:32 AM   #1
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Trying Equal Sector for domestic allocation

Hello.

Iíve begun using an equal sector approach for my domestic allocation. Searching the forums I find a couple of references to people intrigued by the idea but I didnít find anyone reporting on results or their experience with it. I'm hoping some of you who've given it a go will comment.

Briefly here is how Iím implementing it and why it appeals to me Ö not everyoneís cup of tea I fully understand:

* Deploy my US equity allocation equally through the 11 sector ETFs (I use F* with an expense ratio of 0.084% and free trades Ö slightly cheaper than V* curiously enough)

* Use a 5% band approach for rebalancing (sell 2.5% of top sector ETF and buy the lowest anytime the difference hits 5%). Iím still accumulating but when I start withdrawing selling a bit of the winners will replenish short term reserves.

* I know that might sound excessive or needlessly involved but it satisfies my Ďitchy trading fingerí to Ďdo somethingí in a systematic way rather than fighting my instinct to want to tinker (I'm doing this in a pre-tax fund)

* My impulse is always to want to take profits and buy whatever is taking a hit so this approach is more natural to me than letting things ride

* The value and mid-cap tilt appeals to me over a market cap index

* I could just buy EQL and forget it but the 0.3% expense ratio for indexing doesnít appeal

* I know from experience I have no ability to time markets so Iíd rather just buy a little of everything and rebalance systematically

* Iím not expecting magic here. I just think it could give me a fraction of a percent more return at slightly lower risk based on backtesting. If we are indeed entering a low-return environment for an extended period this edge could make a real difference.

I have one IRA that Iíll devote exclusively to this approach so it will be easy to benchmark performance against SPY, EQL, and RSP. If it goes well Iíll share the results
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Old 01-15-2017, 10:06 AM   #2
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Hi,

Welcome!

Can you elaborate a bit more on why you believe an equal sector allocation might outperform at similar (or lower) risk?
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Old 01-15-2017, 12:01 PM   #3
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Thanks for the reply. I've learned a lot from your posts and others here.

I first became interested in this approach by studying sector return charts like these https://novelinvestor.com/sector-performance/

I backtested a few different scenarios like keeping just the top sectors from the previous year, or just the bottom sectors, but none really outperformed just buying them all equally and rebalancing. They all did a little better than SPY.

That's a thin analysis I know with a small sample size and the risk of extrapolating past results to the future. I found one mixed review analysis here Equal-Weighting Indexing: By Sector

I like that this approach should give some risk mitigation for sector bubbles taking profits on the way up.

Thanks for the feedback.
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Old 01-19-2017, 07:10 AM   #4
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Sounds like an unfounded approach to me (sorry if I came across as harsh here).

Issues:
  • Who defines a sector?
  • If you are equal weighing a sector by categories defined by someone else you are effectively over weighing some companies (relative to earnings).
  • This in turn creates a bias towards the smallest sectors. Why would these outperform?
  • Worse, companies in shrinking sectors will get relatively more capital, companies in growing sectors less.


It might outperform anyway, but I don't see it. Might as well do equal alphabet weighing

If all you want to do is avoid bubbles, an earnings or value weighted index might appeal instead.
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Old 01-19-2017, 05:17 PM   #5
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This equal weighting of sectors is what SDOG does with the S&P500, only they are buying the 5 highest dividend yield stocks of each of 10 S&P500 sectors. They rebalance quarterly and while they are picking from the same universe of stocks as the S&P500 since it's inception it has outperformed the S&P500.

The advantage of this approach is to obtain more of the out of favor sector at lower prices and less of the hottest top sectors. In general this is a systematic way to avoid human instinct to go with the hot hand and I think is a solid strategy in general. For instance when Oil and gas recently fell it's influence in the S&P500 declined but an equal sector strategy would be allocating more to the Oil and Gas, when they recovered SDOG overperformed relative to the S&P500 partially because of this, any allocation of stocks is arbitrary in nature anyway as can be seen by the fact Dow Jones alone has 130,000 indices. If it satisfies your urge to take actions in times of market turmoil and allow you to maintain your plan it is a good idea to implement your strategy.
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