Sectors are some of the factors that may influence the choice of going to cash, hedging, or doing nothing when entering a bear market. My previous articles of this series gave examples for consumer staples, industrials, healthcare, energy, materials, consumer discretionary, financials and utilities (last episode here). This one will focus on the S&P 500 Technology sector.
For each sector in the S&P 500 universe, I defined a fundamental ranking process. My Technology Ranking uses three fundamental factors, among them the price-to-book ratio. For the next part, I will use a strategy consisting of a 4-week rotation of the ten stocks of highest rank. It represents about 15% of the reference set: there are currently 65 technology companies in the S&P 500 index. This is not one of my investing strategies, but a model portfolio using common sense and simple fundamental factors. I find it more relevant than using a market cap-based fund like XLK, IYW or VGT.
I have performed three 15-year simulations (1/1/1999-1/9/2014): without protection ("NP"), with market timing ("MT") and timed hedged ("TH"). The portfolio is rebalanced every four weeks. The timing indicator is the same for market timing and timed hedging. It is defined by a bearish signal when the S&P 500 current year EPS estimate falls below its own value three months ago, and a bullish signal when it rises above this value. The hedge is an S&P 500 short position in a 1:1 ratio with the portfolio value (or might be buying SH).
The next table shows simulation results. Dividends are included, transaction costs are 0.1%. A 2% annualized carry cost is applied for temporary hedging positions.
Timed hedging is modeled here in a margin account, and margin costs are included. However, it can be executed without a margin account, by selling 25% of the portfolio and buying SPXU. Previous articles here and here show that hedging is possible with certain leveraged ETFs without fearing their decay.
In this example, the time-hedged version gives the highest total return and the best risk-adjusted performance (Sortino ratio). Here is the equity curve of the "TH" strategy (in red) compared with SPY (in blue):
This is the portfolio with the highest turnover of this series. On average, 2.4 stocks changes every four weeks.
The three highest market capitalizations among current holdings are:
|CSCO||Cisco Systems Inc||118,899.22||Communications Equipment||18.71||3.06|
|EMC||EMC Corp||52,108.56||Computers & Peripherals||20.42||1.58|
|GLW||Corning Inc||26,465.63||Electronic Equipment||14.87||2.19|
As a conclusion, for at least 15 years a timed hedging is the best of the three tactics to protect a model portfolio in Technology. The next article will conclude this series and summarize the results for all sectors.