Last year’s losers usually are among this year’s winners… that’s a strategy that has paid off in a big way for two Asian indexes.
In January, we looked at how a sector rotation investment strategy would work using the Bloomberg World Asia Pacific Index – an index made up of 2500 stocks listed on stock markets throughout Asia. The strategy is to buy the previous year’s worst performing sector and hold it for the current year – and repeat each year. Then its success is measured by whether or not it beats its index.
At the end of 2015, here’s how the Bloomberg Asia Pacific sectors stacked up for the past 11 years, the worst performing sectors are in yellow, the best are highlighted in green:
How it works
For example, applying this strategy, at the beginning of 2014, you would have purchased the energy sector because it was the worst performer in 2013. (An investor would buy a particular sector of this index by, for example, buying an ETF with the component stocks.) At the beginning of 2015, you would sell the energy sector and buy the consumer discretionary sector – the worst-performing sector in 2014.
Following this strategy for the past 11 years would have earned you an average return of almost 13 percent a year. (Total return, using only sectors in the Bloomberg World Asia Pacific Index.) This was more than double the index’s average annual return of 6 percent.
It works for China too
The same strategy applied to China’s CSI 300 Index yields similarly strong results. From the beginning of 2005 (buying 2004’s worst performing sector) to the end of 2015, this approach posted an average return of 29 percent a year (in local currency). That’s more than 16 percentage points per year better than the CSI 300’s average annual return of about 13 percent over the same period.
Following this strategy, at the beginning of 2016 you would have invested in the energy sector, which was the worst-performing sector of both indexes during 2015. The energy sector of the Bloomberg Asia Pacific Index was down 21 percent in 2015, and in China, energy shares fell 18 percent.
As of June 30, the energy sector was down 4.7 percent for the Bloomberg Asia Pacific Index. That’s just a bit better than the index as a whole, which was down 5 percent as of June 30. It’s not the worst performing sector – that would be the consumer discretionary and industrial sectors, both down 10 percent. But it’s far from the best, which is the telecom sector, up 9 percent.
For China’s CSI 300, the energy sector was down 15 percent by the end of June (the CSI 300 as a whole was down 16 percent as of June 30). That’s better than the telecom sector, which is down 33 percent and the market’s worst performing sector. The best performing sector for the CSI 300 so far this year is the consumer staples sector, up 7 percent.
Often, last year’s worst performing sector is among the best performing sectors the following year. But it’s unusual for last year’s worst performer to be this year’s best performing sector. This strategy should not be used to predict the next best-performing sector.
The key to this strategy is consistency – to stick to it year after year. That’s when you will see it outperform the index over time. And it is (barely) outperforming both of the benchmark indexes so far this year, so it is working.
How to follow this strategy
Unfortunately, this strategy isn’t easy to follow. Some sector ETFs are available for the CSI 300 on the Hong Kong Stock Exchange, including energy (code: 3050), financials (code: 2829), consumer staples (code: 2841), materials (code: 3039) and others. But there are no similar ETFs that mirror the overall Asia Pacific Index. (Buying the shares individually that make up the index would be difficult unless you have a particularly large portfolio.)
However, if you’re inclined to follow the strategy for China, the energy sector – although it hasn’t done particularly well in the year to date – is the sector to focus on. The top holdings of the iShares CSI A-Share Energy Index ETF (code: 3050) include China Petroleum & Chemical, PetroChina and China Shenhua Energy Co.