Sector allocation is one of the main pillars in equity portfolio management. In this paper, we examine how the sector price momentum strategy and the cyclical and defensive sector rotation strategy performed in Australia based on the S&P/ASX 200 Global Industry Classification Standard (GICS®) sector indices.
EXECUTIVE SUMMARY
- As measured by the S&P/ASX 200, the Financials and Materials sectors have accounted for 50% of the Australian market since December 1989, but since sectors can fall in and out of favor, mimicking benchmark sector weighting may not be an optimal way to maximize portfolio returns.
- Our study on sector price momentum shows that strong momentum sectors in recent months tend to outperform in coming months, and the opposite holds for the weak momentum sectors, suggesting that sector price momentum can be exploited in sector allocation.
- An unoptimized portfolio with quarterly allocation to the top three sectors based on 12-month price momentum generated an annualized excess return of 4.5% compared with the market between December 1989 and June 2018.
- Cyclical sectors in Australia represented 80% of the total market, but they underperformed defensive sectors on average over the entire period studied, and they only outperformed defensive sectors in 7 of the past 28 years.
- Our study on cyclical and defensive sector performance across global and domestic economic cycles shows the global economic cycle is a stronger driver of relative performance of cyclical versus defensive sectors than the domestic economic cycle in Australia.
- A dynamic allocation strategy that equal weights cyclical sectors during global economic up cycles and rotates to defensive sectors during global economic down cycles achieved an excess return of 5.2% per year compared with the Australian market.
SECTOR DIVERSIFICATION IN THE AUSTRALIAN MARKET
In a previous paper, “Is There Value in Asia Ex-Japan Sector Rotation Strategies?”, we examined how sector allocation based on price momentum and economic cycles performed in Asia, excluding Japan, and we concluded that these two strategies delivered better returns than the benchmark. In this paper, we will study how these two strategies performed in the context of Australian sectors.
Our study focuses on the 11 broad sectors classified by GICS: Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Real Estate, Information Technology, Telecommunication Services, and Utilities. The analysis covers the period between December 1989 and June 2018. We use the S&P/ASX 200 and S&P/ASX 200 GICS sector indices to represent the Australian market and sector performances, respectively, since March 2000, which is when the S&P/ASX 200 GICS sector returns data history begins. For dates before the beginning of the S&P/ASX 200 GICS sector index return data, we use S&P Australia BMI and S&P Australia BMI GICS sector index data.
As of month-end June 2018, the S&P/ASX 200 was diversified into 11 GICS sectors, and some of these sectors can be traded through exchangetraded funds (ETFs; see Appendix for full list of S&P/ASX sector ETFs). Financials was the largest sector in the index by weight (33.1%), consisting of 26 stocks with a combined value of more than AUD 2.2 billion traded daily. Utilities was the smallest sector in the index, weighing merely 2.0% and containing five stocks with a combined value of AUD 114 million traded daily.
