Using Sector Rotation to build Optimised Portfolios

Transcription

1 Using Sector Rotation to build Optimised Portfolios - By Prashanth Angani Founder, Spotalpha.com 6 th December, 2018

2 Introduction Most asset managers know that asset allocation (across Equity, Debt and Cash) is important. This webinar will explain how one can use Sector Rotation to build an optimized portfolio.

3 Investment Strategy Investment Policy Steps involved in Portfolio Design Identify future macro scenarios and their attributes (high inflation, low unemployment, e.t.c). Select the right asset classes to include. Select the weights for each asset class. Identify instruments in each sector, for each future macro scenario. Timing sectors to generate excess return.

4 Step 1: Identify future macro scenarios Investment Policy Every asset manager needs to have a short-term and a long-term macro vision. High Probability Events TRUMP vs CHINA A vision acts as a focal point to know if your portfolio is on track. A vision helps you to have a plan of action for future macro scenarios. TRUMP TWEET Low Impact Events FED RATE HIKE EARNINGS REPORT High Impact Events BREXIT Low Probability Events LEHMAN DEFAULT

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6 Step 2: Select asset classes Investment Policy Every asset class has it s place in an asset managers toolbox. High Return Small cap stocks Selection of asset classes depends on the managers vision for that investment horizon. Low Risk Corp. Bonds Large cap stocks Mid cap stocks High Risk Govt. Bonds Venture Capital Cash Low Return

7 Step 3: Select weights per asset class Investment Policy Asset managers are increasingly following systematic investment management processes. Understanding of Risk has evolved from aversion of losing money to precise statistical values such as maximum drawdown (and standard deviation). Understanding of Return is no longer a value but is measured in terms of risk-adjusted return and Alpha (outperformance). Selecting weights per asset class depends on the investment policy and the investors risk profile.

8 Step 4: Select instruments (1/4) Investment Strategy Start by building investment themes. Each investment theme should have 10 or more stocks with equal allocation to efficiently track a sector. Source :

9 Step 4: Select instruments (2/4) Investment Strategy Identify investment themes that qualify for your investment policy s riskreward profile. Check if these themes/sectors outperform the benchmark index over a long horizon. Reference : Alpha chart is plotted as = Eq. Curve of Sector Eq. Curve of Benchmark Source :

10 Step 4: Select instruments (3/4) Investment Strategy Comparing Alpha of investment themes/sectors over 2yr period narrows down likely candidates. Identify sectors that have significantly underperformed and sectors that have significantly outperformed.

11 Step 4: Select instruments (4/4) Investment Strategy Use Portfolio Optimization individually on each theme/sector Identifies which Stocks within that theme deliver the best risk adjusted returns. How much to allocate to each of those stocks in order to have low volatility of equity curve. Stocks within a sector have high correlation. Portfolio Optimization typically removes more than 2/3 rd of stocks and gives a concentrated portfolio. Source :

12 Step 5: Timing sectors (1/2) Investment Strategy Identify the trend of these sectors/themes (not the stocks within). Any technical trend indicator (SMA, MACD, e.t.c) will give you a good signal if the sector/theme created has more than 30 instruments. Source :

13 Step 5: Timing sectors (1/2) Investment Strategy You can improve your timing by using your trend indicator on the theme s Alpha chart rather than the theme itself. Source :

14 Sector Rotation process Build Investment Themes that represent sectors More than 10 stocks per theme Filter for investment themes that outperformed / underperformed benchmark over long periods Use Portfolio Optimization on each selected theme Shrinks a theme to a handful of stocks Identifies allocation per stock Use a Trend indicator on Theme s Equity Curve or Alpha chart

15 Benefits of Sector Rotation Sector Rotation increases Portfolio asset allocation efficiency (compared to buy and hold). Average trend period of sectors (several quarters) is greater than the average trend period of individual stocks (few months). This reduces trading costs significantly when compared to active investing using trend of stocks. When a sector turns bearish it might take several quarters before it turns bullish again. An asset manager can comfortably allocate such funds to Debt rather than stay in Cash. Hedging using the benchmark index s futures and options becomes easier when timing sectors using trend of the Alpha chart.

16 THANK YOU