What does a portfolio look like if it is populated with eleven Vanguard sector ETFs? Which of the eleven sectors are projected to do well over the next few months? When constructing a portfolio, my preference is to use asset classes rather than sectors for the simple reason that a portfolio built around asset classes will cover all sectors, but a portfolio made up of sectors does not cover all asset classes.
The following analysis projects an annual return of 8.4% or 1.4% points above that projected for the S&P 500. The projected standard deviation is nearly 17.7% or higher than one might prefer. In general, I look for an array of securities that come in under 15% for portfolio volatility and even that is high for retired investors.
Using five years of historical data, a portfolio of sector ETFs lacks proper diversification. Note that the Diversification Metric is only 16% compared to a goal of 40%. The Portfolio Autocorrelation is also rather high at 22%.
Delta Factor: Of the eleven Vanguard sectors, Financials (NYSEARCA:VFH) is projected to perform best over the next 6-12 months. Industrials (NYSEARCA:VIS), Materials (NYSEARCA:VAW), and REIT (NYSEARCA:VNQ) also are projected to outperform VTSMX, Vanguard's Total Stock Market Index fund.
One always needs to remember that the "Delta Factor" indicators are probability projections.
Correlation Matrix: With exception of Utilities (NYSEARCA:VPU) and Energy (NYSEARCA:VDE), all sector ETFs are highly correlated. This is another reason for not building a portfolio using only sectors as the core holdings. When securities are this highly correlated, the Diversification Metric is bound to be low.
If an investor is to take anything away from this analysis it is the following. Consider adding VFH, and possibly VIS, to an existing portfolio. Wait for better opportunities for the other sectors.