Portfolio Design

Advanced concepts in stock investment portfolio design.  Fundamentals, technical analysis and many other related topics are discussed.

Supercharge Your ETF Sector Rotation Strategy

When designing a strategy for trading Exchange Traded Funds (ETFs) it quickly becomes apparent that there are a lack of tools in the war chest. There are the standard technical analysis functions, but that is about it. Today, I want to show the reader a nifty way to increase the number of weapons available to you for sector strategies.  The exciting thing is the same technique can be used for all equity ETF trading strategies, all thanks to Portfolio123.


It is possible to effectively add fundamentals and market breadth-type indicators to your ETF trading strategies. You can do so by using the custom series feature offered by Portfolio123. I am going to show the reader not only how to use custom series to advantage, but also how I set up a basic ETF sector Smart Alpha model using them.

The basic strategy requires that a custom stock universe be set up for each sector.  In the case of sector model I had to set up nine different stock universes.  Note that I said STOCK universes, not ETF universes.  I ignore Telecom because there aren't enough stocks in the universe, possibly making the strategy unreliable.  At the time I designed this model, Real Estate had not been split out as a separate GICS sector yet, hence the reason for 9 sectors. Below is a screen shot of how the industrial sector universe was specified.

Setting up the industrial sector stock universe.

The remaining eight custom universes were created along the same lines as that above.  The next step is to create a set of custom series, one series per fundamental factor of your choosing, for each custom universe.  Below is an example of a custom series for industrials, using Analysts mean price target divided by the current stock price.  The series is market capitalization weighted, meaning that the larger the stock's MarketCap, the more weight is assigned in the aggregate value. There has to be more than two analysts following the stock, or else the stock is not included in the aggregate.

Example of using analyst price target mean price in a custom series.

Once the custom series has been specified then click on the CHART tab.  Update the custom series chart with weekly rebalance starting from an early date such as the beginning of the year 2000. Click on the UPDATE button.  Once the graph has been drawn then click on Save. This last operation is very important and tends to mess me up a lot!

Updating the custom series chart with weekly rebalance.

As I mentioned earlier, a custom series has to be generated for each sector, for a total of nine (ten if you include real estate). Then if you want to use another fundamental factor, then you have to repeat the entire process of generating custom series. And so forth.

Once you have finished with generating custom series, then the next step is to create a bunch of custom formulas.  The reason for this is to minimize the amount of text once you get into the ranking system design, which becomes quite unmanageable very fast.  For my Smart Alpha model, I used a total of three fundamental factors. Unfortunately I cannot provide details on what the actual fundamentals are that I am using. The custom formulas are listed below. 

Map all of the Ticker("xxx") calls using custom formulas in order to shorten the text.
Map all of the custom series calls using custom formulas in order to shorten the text.

I mapped the ETF ticker names to custom formulas, and also smoothed values of the custom series.  Only one of the fundamental factors is shown above, so imagine 3x this number of custom formulas.

Now comes the interesting part.  In the ranking system shown below, I have associated one custom series with each sector ETF, and it all has to be done within one ranking node.  I have three nodes because there are three fundamental factors.

The logic goes as follows:  If the ticker is the Healthcare ETF (XLV) then use the Healthcare custom series for fundamental factor xxx (tXLV).  Otherwise, if the ticker is Staples ETF (XLP) then use the Staples custom series for fundamental factor xxx (tXLP).  And so forth, for all nine sector ETFs.

The same type of logic is used for the other two nodes, but for a different fundamental factor.  Do not mix fundamental factors within a node or you will get screwy results.

Example sector rotation ranking system

Once the ranking system has been set up then the next step is to create a custom universe with all nine sector ETFs in it (not shown).  Finally, set up a simulation or port that calls up the custom universe with all nine sector ETFs called up, and the sector ranking system that was specified above.

The last thing to remember is to call out the custom series in the buy rules for the model or portfolio as shown below. This will cause all of the custom series to be updated when necessary.

Custom series update using portfolio buy rules

Custom series update using portfolio buy rules

My recently launched Smart Alpha sector Exchange Traded Fund (ETF) model will be available to subscribers at a modest price in about 2 1/2 months. 

Recently launched Smart Alpha sector rotation Exchange Traded Fund (ETF) model based on aggregate stock fundamentals.

Recently launched Smart Alpha sector rotation Exchange Traded Fund (ETF) model based on aggregate stock fundamentals.