Nine Twists On Sector ETF Investing

by on April 29, 2010 | ETFs Mentioned:

ETFs were originally embraced by buy-and-hold investors as an optimal, low-cost vehicle for inclusion in a long-term retirement portfolio. But in recent years they have become popular among more active traders who value their liquidity and efficiency in providing exposure to various asset classes. Once used primarily by beta grazers, ETFs have become a favorite tool of alpha hunters looking to generate excess return (see Five ETFs With Surprising Turnover).

Some of these active investors use ETFs to tilt portfolio weightings between different asset classes and national economies. Other investors have strong opinions about the relative prospects of certain sectors of the U.S. economy, and pursue alpha through by overweighting those industries with the brightest prospect and underweighting (or even shorting) those expected to struggle.

A number of sector-specific ETFs have been introduced in recent years, including the recent launch of small-cap sector ETFs from PowerShares. But the most popular options for achieving sector-specific exposure through ETFs are the nine sector SPDRs from State Street, each of which consists of the S&P 500 components that belong to a particular industry.

While these sector SPDRs offer targeted exposure to every corner of the U.S. economy, there are several other interesting options for investors playing a sector rotation strategy or looking to overweight a certain industry. Below, we profile nine ETFs that might be unfamiliar to many investors but provide a unique way to access sectors of the economy:

Technology

The Usual: Technology Select Sector SPDR (XLK)

The Twist: S&P North American Technology-Software Index Fund (IGV)

This ETF focuses on the software corner of the technology market, investing in companies that are producers of enterprise software, Internet software, and entertainment software. IGV tracks the performance of the S&P North American Technology-Software Index, a benchmark that includes about 50 stocks (compared to 85 for XLK). Major holdings in IGV include Oracle, Microsoft, and Adobe. IGV charges an expense ratio of 0.48%.

Consumer Staples

The Usual: Consumer Staples Select Sector SPDR (XLP)

The Twist: Dynamic Food & Beverage Portfolio (PBJ)

This ETF is centered on a very targeted corner of the consumer staples industry, investing in companies that engage in the distribution, sales, or manufacturing of food and food technology. PBJ follows the performance of the Dynamic Food & Beverage Intellidex Index, a benchmark that includes companies like Coca-Cola Enterprises, General Mills Inc., and H.J. Heinz Company. PBJ has an expense ratio of 0.60% (see Does Your Portfolio Have A Craving For PBJ?).

Consumer Discretionary

The Usual: Consumer Discretionary Select Sector SPDR (XLY)

The Twist: Claymore/Robb Report Global Luxury ETF (ROB)

This ETF includes securities of companies which concentrate on luxury goods and services:  travel, leisure, investment, retailer, and manufacturer firms. ROB tracks the performance of the Robb Report Global Luxury Index and charges an expense ratio of 0.70%.  Top holdings for ROB include Swatch, Cie Financiere Richemont, and PPR (ROB gives allocations of about 27% to both France and the United States).

XLY’s underlying holdings consist of companies like McDonald’s, Home Depot, and Target–not exactly the destinations most consumers imagine when considering discretionary spending. ROB, on the other hand, invests in companies engaged in the production of high end goods, and as such may provide more pure play exposure to consumer spending habits during certain economic cycles.

Financials

The Usual: Financials Select Sector SPDR (XLF)

The Twist: SPDR Capital Markets ETF (KCE)

Like many ETFs on this list, this ETF offers more targeted exposure to the financial sector than the broad-based sector SPDR. KCE is comprised of publicly traded companies, within the financial sector, that function as broker-dealers, asset managers, trust and custody banks or exchanges. KCE tracks the performance of the KBW Capital Markets Index which includes 24 stocks. KCE major holdings include Morgan Stanley, Goldman Sachs Incorporated, and State Street Corporation. KCE charges an expense ratio of 0.35%.

Health Care

The Usual: Health Care Select Sector SPDR (XLV)

The Twist: Dow Jones U.S. Healthcare Providers Index Fund (IHF)

This ETF focuses on the healthcare sub-sector within the U.S. equity market, investing in owners of health maintenance organizations, hospitals, clinics, nursing homes, and rehab centers. As investors continue to analyze the impact of recent legislation on the health care sector, this ETF figures to be in focus quite a bit.

IHF tracks the performance of the Dow Jones U.S. Select Health Care Providers Index, which has 48 stock holdings (compared to 53 for XLV). The top holdings in IHF are UnitedHealth Group, Medco, and WellPoint. IHF charges an expense ratio of 0.48%.

Materials

The Usual: Materials Selects Sector SPDR (XLB)

The Twist: S&P SmallCap Portfolio (XLBS)

Whereas XLB invests in materials companies included in the S&P 500, XLBS is comprised of common stocks of basic materials companies included in the S&P SmallCap 600. Components  include producing raw materials, paper or wood products, mining, metals, chemicals, and construction. Historically, small cap stocks have exhibited a different risk/return profile than large cap equities, generally delivering higher but more volatile returns (see more on PowerShares’ small cap sector ETFs).

XLBS tracks the performance of the S&P SmallCap 600 Materials Index. Top holdings in XLBS are Rock-Tenn Company, New Market Corporation, and Eagle Materials.  XLBS charges an expense ratio of 0.29%.

Industrials

The Usual: Industrials Select Sector SPDR (XLI)

The Twist: Aerospace & Defense Portfolio (PPA)

This ETF invests in companies associated with developing, manufacturing, and operating U.S. defense, homeland security, and aerospace. Again, PPA offers exposure to a particular sub-sector of the industrials industry, and will be influenced by changes in defense spending. This ETF tracks the performance of the SPADE Defense Index. Major holdings of PPA, as well as XLI, include United Technologies Corp., Boeing, and Honeywell. PPA charges an expense ratio of 0.60%, and has lagged behind the broad-based XLI so far in 2010.

Energy

The Usual: Energy Select Sector SPDR (XLE)

The Twist: S&P Oil & Gas Exploration & Production ETF (XOP)

This ETF consists of stocks in the oil and gas exploration and production sub-industry in the S&P Total Markets Index. In addition to “Big Oil,” this ETF includes companies that are involved in searching for oil reserves, such as Apache and XTO Energy. XOP follows the performance of the S&P Oil & Gas Exploration & Production Select Industry Index and charges an expense ratio of 0.35%. Like XLE, this ETF tends to exhibit a strong correlation with oil prices, since demand for the services of component companies tends to rise when crude prices do.

Utilities

The Usual: Utilities Select Sector SPDR (XLU)

The Twist: S&P Global Infrastructure Index Fund (IGF)

While XLU focuses primarily on domestic equities, IGF focuses on the performance of the global infrastructure sector, investing in stocks listed in more than a dozen countries. The U.S. accounts for only about a quarter of IGF holdings, with Canada, Germany, and Australia also receiving big allocations (see IGF’s country breakdown).

This ETF tracks the performance of the S&P Global Infrastructure Index, which includes big weightings to TransCanada, Enbridge Inc., and Abertis Infraestructuras. IGF charges an expense ratio of 0.48%.

Cathy Carlson contributed to this article.

Disclosure: No positions at time of writing.