Active Stock Picking vs. Indexing Challenge

[Mr. Now]

I'm not taking Rock's bet. He's the clear favorite.

About 70% of return in not individual security selection but rather the fractional allocations to stocks, bonds, cash.

Ditto within the Stock segment. There about 70% of return is not individual stocks but rather sector exposure.

It follows that in any sector the possibility exists for outperformance by a hand-picked basket of individual issues.

But, since the individual issues picked are also typically members of the overall ETF sector index, over time the individual issues will tend to regress to the sector mean. This is especially true of the leading issues in the sector, of which the ETF is typically overweight.

I like his reasoning. His is a strong argument for focusing attention on sectors and not individual issues.

The structure of the market also supports this idea. There is an enormous amount of money- hundreds of billions-- that will leave the stock market only stubbornly. If at all. This money switches from offense to defense but rarely exits the market.

Instead the money rotates among the many sectors.

One strategy is to make a sector bet and place a small portion of the total bet in 1,2 or 3 of the leaders in the sector.

For example for a single sector bet, the structure may be:

Sector ETF = 90% of total bet,
IssueA = 5% of total bet and
IssueB = 5% of total bet.

This makes you overweight in the leaders in the sector. It's a fairly aggressive approach whose additional risk can be managed via the use of stops.

If you have an interest in focusing more investing attention on sectors, take a look at John Murphy's daily Market Message service. It is a good tool and a great value.

Reference:
http://stockcharts.com/corp/MurphyDetails.html