Surviving Black Swans III: Timing US Sector Funds

Abstract

The typical small investor makes on average about 5% a year in investment gains, just half of what the market does. Moreover, most investment funds also underperform compared to the broader market. In two previous papers, we explored how a specific and simple approach to algorithmic trading can help both types of investors achieve strong results. For concreteness, we focused attention on investing in a single variable, in our case, a major US-based index such as SPX and IXIC, individually. For illustrative purposes, we also considered some highly traded tech stock examples. In this paper, we extend our work to study the US sector funds, and for the first time in our series, we also consider trading multiple variables at a time to see how that may differ from our single-variable investment strategy. To simplify matters, we consider an initial equal weighted portfolio of several sector funds, selected randomly without any analysis, and assume that each is traded independently. To simplify further, we do no rebalancing in our study, though that is an essential part of money management according to modern portfolio theory. We nevertheless obtain interesting and informative results. We can typically improve on the performance of most sector funds compared to buy-and-hold (hereafter referred to as BnH). Moreover, as an example of portfolio growth, a portfolio of five equal weighted sector funds in BnH achieves 6.5× growth over 20 years (ending in March 2023), whereas our approach achieves 12.4× growth—nearly 2× better, at roughly half the maximum drawdown. That is a strong win for both professional and home investors.