A New ETF Portfolio

11/03/2006 12:00 am EST

Focus:

John Bollinger

President and Founder, Bollinger Capital Management

If you want a comprehensive explanation of the thinking behind successful investment strategy, John Bollinger is an excellent source. In his new update to his portfolios, he takes subscribers on a fascinating journey from idea inception to investment execution.

"My focus this past month has been on adding a sector rotation program to our Exchange Traded Funds (ETF) portfolio. Earlier in the year we introduced a new selection methodology and last month we introduced a revamped International ETF portfolio. Now we reintroduce - after a long hiatus - a revamped Sector ETF portfolio.

"We found 74 sector funds with more than a year of history to work with. The first cut was to remove the sixteen HOLDRs. These only trade in round lots, multiples of a hundred, and some trade in the $150 range, so the smallest increment available to the trader is about $15,000. This is far too large for initial position sizing, trimming and rebalancing in a portfolio where multiple securities will be held. Rebalancing is key to performance. That left us with 58 candidates and lots of overlap.

"Our first pass was to break the funds into their logical subgroups, utilities, basic materials, etc., run correlation tests on the groupings and select funds in the groupings with the highest dollar volume and the lowest correlation coefficients. Following that, we ended up with a list of 30 or so candidates. However, we were in for a surprise. When we ran the cross-correlations it resulted with a large number of highly positively-correlated funds, even though we had only selected one or two funds from each grouping. This was not totally unexpected. The problem is that there is a lot of discretion as to what goes into a basic materials fund or a financial fund. The definitions are fuzzy at best and sometimes simply incomprehensible. So we went back to square one and started running cross-correlations on all 58 funds, addressing first the items that exhibited multiple high correlations and then working our way down the list until all of the highest correlations were eliminated.

"The threshold was dropped and the process repeated again. The result is a list of 27 sector ETFs that we will be using in this portfolio. We find it quite interesting that this process lead to a portfolio that had very little overlap in name as well as in fact.

Here is a small selection from the Sector ETFs we will use initially: iShares Comex Gold Trust (IAU AMEX), iShares NASDAQ Biotechnology (IBB AMEX), iShares Goldman Sachs Networking (IGN AMEX), and iShares S&P Global Financials (IXG AMEX), and iShares Dow Jones US Real Estate (IYR AMEX)."

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