ETF ACADEMY: Rebalance vs. Rotation

Two terms in the ETF world that can confuse investors are rebalance and rotation – what’s the difference?

Obviously, both terms describe change, however, there are important differences between the two when it comes to managing your portfolio with ETFs.

Rebalance

Rebalancing your portfolio means getting back to your ideal mix of investments. The balance of stocks vs. bonds vs. commodities will change over time as the value of your investments go up (or down) at different rates. For example, let’s use a target portfolio mix of 60% stocks, 30% bonds and 10% commodities.

If over the course of a quarter stocks decline, bonds remain flat and commodities are on fire, you could end the quarter with a mix of 50% stocks, 30% bonds and 20% commodities. To back to your ideal mix, you would rebalance your portfolio by selling some of your commodities and buying additional stocks. This approach has the additional benefit of forcing you to sell high and buy low on a regular basis.

If that sounds like too much work, don’t worry. A good financial advisor can do the rebalancing for you, preferably with ETFs. We’re putting together a list of financial advisors that offer a balanced ETF portfolio service. If you are interested in receiving a copy when it’s ready, subscribe to our free Investing with ETFs newsletter.

One firm that has launched a series of model ETF portfolios that rebalance over time is TD Ameritrade with a service called Amerivest Target Date Investment Portfolios. The Amerivest portfolios are designed to match the time frame of your financial goal using a professionally designed portfolio of ETFs that provide a diversified exposure to a variety of asset classes. Portfolios typically begin by aggressively pursuing capital appreciation, while accepting significant risk. Then, as the target date approaches, allocations shift to lower risk profiles to help preserve accumulated assets.

See the TD Ameritrade website for more information.

Unfortunately, there is not an ETF in the U.S. that provides a balanced approach across asset classes. Claymore launched two balanced ETFs in Canada last year that trade on the TSX. We would be surprised if we don’t see a similar offering in the U.S. before the end of 2008 from at least one of the sponsors.

In the mean time, if you only need help with rebalancing one part of your portfolio such as equities, take a look at Rydex Investments which has a family of equal-weighted ETFs. Equal-weighting means that each holding in the the fund has an equal chance of influencing the performance. The flagship of this group is the Rydex S&P Equal Weight ETF (Amex: RSP) which tracks an index that includes each member of the S&P 500 at 0.2% of the portfolio and rebalances quarterly.

For more information, see the Rydex website.

A couple of watch outs on equal-weight ETFs. First, expenses are likely to be higher than average due to expenses associated with rebalancing. That said, RSP has a reasonable expense ratio of 0.4%. Also, there is greater possibility of a taxable capital gains distribution associated with equal-weight ETFs.

Rotation

Sector rotation is an investment strategy involving the movement of assets from one industry or sector to another in an effort to capture the performance momentum of a specific sector in relation to the economic cycle.

Several ETFs offer a way to pursue an active rotation strategy at a low cost.

Claymore is also a player in rotation offering 4 products that include international, Canadian, all-cap and large-cap ETFs. The large-cap fund is the Claymore/Zacks Sector Rotation ETF (Amex: XRO) which overweights cyclical sectors prior to anticipated periods of economic expansion and overweights non-cyclical sectors prior to anticipated periods of economic contraction.

As you can see in the chart below, XRO has outperformed the market since its launch in 2006.


For more information, see the Claymore website.

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