Bridge over ocean
1 September 1986 Financial Analysts Journal Volume 42, Issue 5

Portfolio Returns from Active Industry Group Rotation

  1. Eric H. Sorensen
  2. Terry Burke

The relative price performances of 43 industry groups over the 1972–84 period indicate that, while individual industry rankings varied considerably, industry-specific stock price movements tended to persist for at least two quarters. This suggests that a strategy based on buying and holding the best performing industry groups—a naive strategy that requires only knowledge of past information and no superior forecasting ability—may enhance portfolio returns.

In fact, a strategy based on rotating portfolio holdings among the three, five or 10 best performing industry groups over the 1972–82 period resulted in superior returns. Each portfolio was revised quarterly to sell any group that had dropped a certain percentage in industry ranking and replace it with the best performing industry group not already held. Gross returns over the period ranged from a low of 9.32 per cent annually for a five-group portfolio to a high of 16.8 per cent for a three-group portfolio, compared with an annual market return (as measured by the S&P 500) of 6.56 per cent. Even after risk adjustment and transaction costs, more than half the portfolios outperformed the market.

Obviously, such a strategy requires that a portfolio manager be willing and able to absorb the increased risks associated with underdiversification. Also, the strategy results in negative excess returns in certain market environments. Nevertheless, group rotation, judiciously applied and used in the context of an overall diversified plan, may improve portfolio performance.

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