The objective of such strategy is to select the best performing sectors assuring the desired level of diversification. It allows the analysis of cross-strategies funds and across different asset classes. The strategy includes the use of macroeconomic data, factor models, and sector-specific models.
Usual market data used in the top-down research and analysis includes sector stock indices, growth rate of the economy, credit spreads, interest rate volatilities, and changes in the yield curve. The critical factor for the success of this strategy is to choose the correct sectors as well as to avoid lagging sectors.
An equity manager would trade cyclical stocks following the dynamics of the business cycles. A bond portfolio manager would design the strategy on the basis of predicted changes in the shape or level of the yield curve.
It includes varying the weights of the bonds in the portfolio assigned to the different sectors of the issuing companies. An instrument that is frequently associated with sector strategies is exchange-traded funds (ETFs).
ETFs are index tracking exchange-traded products and many of them track sector indices. Because they can be traded as a stock, admitting short sales, sector ETFs are ot en included in long/short portfolios that aim to replicate hedge fund returns distribution.