Would someone mind analyzing this investment strategy?

Question

I'm a big fan of index funds, particularly Vanguard's 500 Index and any EAFE (international) index.

I feel, however, that indexes like the S&P 500 could be "tweaked a bit" by excluding those sectors or industries of the economy that have traditionally not done well in a long time.

For example, I'd be interested in an S&P 500 index fund MINUS industries like food production (which has posted negative returns in profits AND shareholder value for the past 10 years!) and several others. Is this a sound strategy?

On a similiar note, is there any website that shows a COMPLETE history of economic sectors of the stock market? I'm interested in finding if any one sector has consistently beaten other sectors of the market over 20 or even 30 years of time (not interested in YTD, 3 or 5 year charts, though).

Thanks for your help.

Answer 1

Index fund investing is built around the central tenet that there is no reliable way to predict in advance which stocks are going to outperform the market. Your idea of excluding out-of-favor sectors strikes me as a reasonable attempt to improve on the indexes. Just keep in mind that an out-of-favor sector may very well be primed for a rebound and may actually outperform the market while you're avoiding it. After all, there's a reason they include the disclaimer in mutual fund prospectuses, "Past performance is no guarantee of future results".

Answer 2

There are index funds that attempt to do what you wish to do. They just are not the S&P 500 index fund.

Here are some examples:

EEZ a relatively new index fund by Wisdom Tree. Invests only in the 100 companies with the highest earnings yield. Sounds exactly what you might be looking for. The portfolio is reconstitued each year disposing of those companies that do not make the grade.

PIV might also offer what you are looking for. It is indexed to the Value Line timeliness recommendations.

If you would like some foreign exposure (recommended), then ADRD might be a good choice.

One thing to keep in mind with index funds especially is that many are capitalization weighted, especially the S&P 500. As a result most of your investment is concentrated in about 20 securities. The other 480 are window dressing so to speak. RSP addresses this problem, if you consider it a problem.

Answer 3

The strategy is fine except you must realize that you are defeating the purpose. What you are doing is simply what managed mutual funds do. They compare to the benchmark and then attempt to choose stocks that will outperform the benchmark. 75% of mutual fund managers do not beat the benchmarks. You very well might do well but it's hard to predict which sectors will outperform/ underperform on a year to year basis. On a longer term view you might miss the upside of a sector that underperforms for a long time and suddenly goes up big. Check the site below for some ofthe sector return values. That only shows one day but I'm sure you can get longer stretches out of that site.

Answer 4

Index funds suck for the reason that you cited. Even though their fees are extremely low, the always underperform the index by the amount of the fee.

Example- S&P 500 does 10%, Vanguard expenses are .10%
Your return = 9.90%

SIMPLE.

Look for fund managers, ETFs or otherwise that have historically outperformed the index. 20% of funds have on average over the long term outperformed. Either hire a pro or do the research yourself.

Answer 5

This sounds like an interesting strategy to help you beat the market average. The main reason I don't like index funds is that when you are that diversified it will make it very difficult to ever beat the market average. Excluding unfavourable industries should help you beat the market, but not by a ton, as you will still be fairly statistically tied to the average. It certainly shouldn't hurt to exclude unfavourable industries though.

I personally prefer to invest in individual companies instead of entire industries, but to each his own! I do think your strategy should work. I do not know if they have an S & P 500 fund minus your select industries. Perhaps you should just invest in industry specific ETF's?

Answer 6

The strategy you are asking about is called qualitative analysis. Vanguard's Growth & Income fund takes the S&P500 stocks and uses that strategy to find the best in their opinion. The G&I fund holds about 117 stocks and the returns are close to the index fund.
500 Index (G&I fund) Returns to 4/30/07.
1 year 15.07% (14.65%)
3 years 12.25% (12.23%)
5 years 8.41% (8.70%)
10 years 7.96% (8.70%)
since inception of G&I fund on 12/1986
11.66% (11.87%)

Answer 7

What you want is the XL ETFs such as XLU (Sp 500 utilities), XLI (SP 500 industry) and XLF (Sp 500 finance). That way you can own certain sectors of the SP 500, but not all of it. You might find the charts you are looking for in the business section of a college or university library. Even your local large library might have such charts.

Answer 8

I don't know of a website that will give you the sector data that you're interested in for free, but Telechart (for about the price of a soda per day) provides industry data from the Hemscott data source and goes back to 1990. I've found this invaluable in my sector and technical analyses.
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Answer 9

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