Sector Fund Rotation System Outperforms the Market

The overall stock market has had a rough seven years. If you look at the performance of the S&P 500 from 1999 through 2005, you'll see that it was up about 0.2% compounded annual return, not much better than a savings account, and the Nasdaq 100 has fared even worse. It got there in an interesting way, but overall it basically went nowhere.

For investors looking to improve that performance, what alternatives to index funds or buy and hold investing are there? Sector mutual fund investing, using a rotation strategy has been shown to work by a variety of different newsletters and advisors. Many of the top performing advisory newsletters in the Hulbert Financial Digest use this type of strategy. This is easily done using sector funds, such as the Fidelity Select Funds family.

Here we look at a mutual fund trading system that trades the Fidelity Select Mutual Funds. The Fidelity Select Mutual Funds are a good choice for several reasons:

* Fidelity Select Mutual Funds historically have persistence in their trends so they can be held for the Fidelity imposed minimum 30 day holding period while realizing a return well above that of the market.

* If the funds are held for a 30 day minimum, Fidelity allows unlimited trading with no redemption fees.

* With over 40 Fidelity Select Funds, there is a sector fund is available to track most market sectors. If there is strength in any domestic market sector, you’ll probably capture it using Fidelity Select Funds. The diverse choices include Fidelity Select Energy, Fidelity Select Biotechnology, Fidelity Select Gold, and Fidelity Select Health.

* Fidelity's minimum investment for the Fidelity Select Funds is only $2500 per fund, so that’s all you need to start. There is no longer a load on the Select funds.

Many Fidelity Select rotation strategies have been published, dating back to the late 1990’s, but this example is one of the simplest to follow. The steps are as follows:

1) Track the 25 day (or 5 week) price change in all Fidelity Select Mutual Funds.

2) Invest in the Select Fund with the highest percentage gain over that 5 weeks.

3) Hold the top Select fund for at least 30 calendar days, to avoid the Fidelity early redemption fees.

4) After 30 days, if the currently held Select Fund is still the top Select fund, continue to hold it. Otherwise, exchange it immediately for the top ranked Select fund.

5) Hold the new Select Fund for 30 calendar days

For the 1999 to 2005 years that the major indices have been almost flat, this sector fund rotation system gained almost 200%, or about 16% per year.

There is one significant weakness to this strategy. It’s drawdown is about the same as the overall market. During the down years of 2000 to 2002 this strategy had a drawdown of almost 50%. Fortunately, it has achieved new all time highs in 2006, but that kinds of drawdown need to be factored in to how much you might want to invest in this or any investment strategy.

As you can see, even a simple sector rotation strategy can give a real performance advantage over buy and hold investing. This simple Fidelity Select Funds trading system is a great example.

John Ruppel is the managing principal for Fundztrader.com. Fundztrader offers model portfolios featuring Fidelity Mutual Funds, Fidelity Select Mutual Funds, and Exchange Traded Funds. More information and a free newsletter are available at http://www.fundztrader.com