Sector breakdown analysis of my Magic Formula Fund

About a month ago, some friends were suggesting that perhaps the reason that my Magic Formula Fund (MFF1) is outperforming the Market (S&P 500) is simply because Magic Formula explicitly avoids purchasing any Financial (Banks, Insurance Cos, Mutual Funds, etc) and Utilities stocks. (The underlying reason for this is explained in some detail in the Little Book. I will not get into it here.) I was intrigued by my friends' arguments. So I did some analysis.

I was able to find that the Finance and Utilities sectors made up about 15% and 4% of the S&P. Here is a breakdown of all sectors:

source: http://quicktake.morningstar.com/etfnet/Snapshot.aspx?Country=USA&Symbol=IVV


And, in the last 14 months, the performance for the finance and utilities sectors have been about -20% and +12% respectively.

source: http://stockcharts.com/charts/performance/SPSectors.html


So the combined effect of those 2 sectors on the S&P500 index has been about -2.52% ((0.15 x -0.20) + (0.04 x 0.12)). Still quite short of the 10%+ difference my Magic Formula Fund has achieved so far.

Going through this exercise made me to look into my own Magic Formula Fund's sector breakdown in more detail. Below is the details of my analysis (as of about 1 month ago)  which suggests that I have invested more heavily in certain sectors than a S&P500 distribution would suggest.

Yellow colors indicate the number of stocks (out of 36) that I should have allocated to each sector. The green colors display the actual positions that I took in each sector. So I am heavy on the Service Sector (especially Business Services) and light on Manufacturing and Information sectors.

I have taken these facts into account in my last month's picks, and I plan to follow similar thinking during the upcoming months. I will try to balance out my portfolio's sector distribution similar to the S&P500's. After all, I would like to beat the S&P500 index with as close a sector distribution as possible.

Having said that, I am fully aware that sometimes the nature of the Magic Formula approach will favor certain sectors over others simply because a sector is beaten down and it just offers many good opportunities to buy good companies at cheap prices. And I might just take advantage of those opportunities.