Sector rotation

Not every sector does well at the same time. Banks, pharma, IT and airlines each have their own good years and bad years, driven by different forces in the economy.

Sector rotation is a strategy built around that fact. A manager raises the weight of sectors she expects to do well. She cuts the weight of sectors she expects to lag. She is betting on sectors, not on the market as a whole and not on individual stocks.

The workbook's own example is the Covid-19 pandemic. Pharmaceuticals and consumer staples did well. Airlines, hospitality and white goods struggled. A sector-rotation manager would have shifted weight from the second group toward the first.

The workbook names sector rotation a 'top-down' strategy (section 18.2.2): the manager first reads macro-economic factors to judge the current phase of the economic cycle, then uses key economic indicators to identify the sectors that phase favours. Weight is then raised or cut sector by sector inside the equity portfolio.

The workbook gives no percentage, formula or numeric threshold for sector rotation itself — it is described qualitatively, illustrated only by naming which real sectors gained and lost during the Covid-19 pandemic (financial services, consumer goods, transportation, technology, pharmaceuticals and real estate are the sectors it names as examples of divergent behaviour). The workbook does flag two costs directly: sector rotation 'at times, lead[s] to higher concentration risk', and because it means frequent buying and selling, it results in higher trading costs that eat into the portfolio's return.

Illustrative figures. A Rs 20,00,00,000 equity PMS portfolio starts with a sector mix of Financials 25%, IT 20%, Pharma 8%, FMCG 12%, Auto 10%, and others 25%.

Reading an early-cycle recovery, the manager rotates: Financials is raised to 32% (buying Rs 1,40,00,000 more) and Auto to 15% (buying Rs 1,00,00,000 more), funded by cutting Pharma to 4% (selling Rs 80,00,000) and FMCG to 8% (selling Rs 80,00,000) — sectors she expects to lag in a recovery.

Over the next year, Financials return 22% and Auto 19%, against Pharma's 6% and FMCG's 9%. The rotated weights earn roughly Rs 61,60,000 more than an unrotated portfolio would have earned on the same starting capital. Had the recovery stalled instead, the same rotation would have cost the portfolio just as directly — sector rotation is a forecast, not a guarantee.

Chapter 18 (Equity Portfolio Management Strategies), section 18.2.2, defines sector rotation as a top-down active strategy and gives the Covid-19 sector-divergence example. Expect a question naming a real-world event and asking which sectors a rotation manager would overweight or underweight, and one testing whether sector rotation is top-down or bottom-up.

• Sector rotation is top-down, unlike stock-picking (bottom-up); do not confuse the two directions.
• It is a form of active management, so it carries the workbook's usual active-management costs, and the workbook specifically names higher concentration risk as a side effect of overweighting fewer sectors.
• Frequent buying and selling raises trading costs, which eats into the very outperformance the rotation is trying to capture.
• Do not confuse sector rotation with market timing (section 18.2.1) — market timing shifts the portfolio's overall market exposure (cash versus equity, or beta), while sector rotation reallocates within the equity sleeve across sectors.