The rise of ETF's has caused a major change in trading, particularly in sector rotation strategies. There are several good current articles on this subject.
The Float, which does a nice job of covering developments in ETF's, cites an article by Michael Sesit on how ETF's threaten actively managed funds. This is a very significant development. The regular mutual funds can outperform only by making big sector bets, but turning the positions is a slow process. For the big funds, changing sector weightings is like turning an oil tanker. ETF trading is much more subject to "hot money." Market participants, including individual investors, financial consultants, and hedge fund managers, switch ETF's in a heartbeat. Transaction costs are low. There is often no detailed analysis of fundamentals. If someone has the idea, for example, that energy is "toppy"', it is easy to sell anything related to energy. Individual stocks, whatever the merits, go along for the ride. Long-term investors must understand and ignore this, while traders need a faster trigger finger.
Abnormal Returns also frequently covers the ETF universe. In an important article, the author provides a valuable insight on the birth and death of ETF's, and why investors should be paying attention to fund assets and potential liquidations.
Investors trying to achieve superior performance through sector rotation must use the following criteria:
- Does the ETF have real liquidity?
- Does it overweight a few names, providing little overall exposure?
- Does your strategy provide an element of anticipation?
- Does your approach exit in a timely fashion?
Meeting all of these tests is essential for successful ETF trading and investing.