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Investment Strategy: Index Rotation

Editor's note: This was originally published in on RealMoney. It is being republished as a bonus for readers.

The goal of this series is to provide ideas on how you should structure your investments and offer a basis on which you can read and understand my daily commentary and weekly columns. In part one of this series, I gave an overview of my investment strategy, mostly from an asset allocation perspective.

Index Rotation

The largest portion of my investment strategy for stocks is two index rotation strategies executed through exchange-traded funds. The models provide monthly signals but the average holding period ranges from four to seven months. The goal is to identify themes that will outperform the market over the holding period by producing a return in excess of the S&P 500.

I developed the initial form of this strategy toward the end of my 15-year tenure at my last job, where I managed money for high net-worth individuals and ran the equity research department. Investment performance had gone through a tough period leading up to and after the bursting of the dot-com bubble in 2000.

I was growing frustrated with our large-cap growth at the right price strategy. I felt then and still believe that the advances in information and communication technology had eroded the edge of professional investors, even those who had the best insights and performed the most thorough and insightful analysis. The collapse in trading commissions further evened the playing field.

About the time my frustrations were peaking, I met a new prospect with millions to invest. The prospect had a complex set of accounts that needed better organization and oversight. The caveat was that the clients did not believe in active management using individual stocks. They were pretty well read and knew that most money managers did not outperform their benchmarks.

This presented a bit of conundrum for me. There was no way I was going to turn away a multimillion dollar prospect, but I knew I had to be honest and tell them that index investing was not what my firm did. I asked if the index strategy could be slightly modified to give my firm the authority to rotate among a group of indices. There would be a buy and hold aspect but within ranges I asked for the authority to move among indices based on market cap, economic sectors and international investments.

Don't miss this index-related story: 'Cubes' Drops Into 'Also Ran' Territory
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