Three Sector ETFs With Sky-High Betas

by on May 19, 2010 | ETFs Mentioned:

What seemed to be a stable market recovery has encountered some turbulence in recent weeks, as lingering uncertainty in the euro zone has rippled throughout the global economy. Recent market volatility–the iPath S&P 500 VIX Short-Term Futures ETN (VXX) has posted a remarkable gain of 45.4% over the past month–has caused a variety of responses from investors. Some have sold off risky assets in favor of safe havens like gold and U.S. dollars, while others have slid down the risk profile to less volatile equities (see Three Low Beta ETF Options). And then there are the contrarians who subscribe to the old Buffett mantra of being “greedy when others are fearful.”

Many investors who are buying when others are selling–hoping to scoop up bargains at an attractive entry point–have an appetite for risk, seeking out securities that will perform well if recent trends reverse. Below we profile three ETFs that offer significantly greater volatility than the overall market:

Market Vectors Coal ETF (KOL) Beta=1.73

Coal generates close to half of all the electricity in the United States and close to 70% of the power in China, suggesting that the rock will remain in high demand for years to come no matter what happens with alternative fuel sources. KOL tracks the Stowe Coal Index, and has exhibited high levels of volatility in recent years see technical analysis of KOL). A possible reason for this higher than expected volatility could be the fund’s heavy allocation to international stocks. More than 50% of the fund is allocated to international firms, with the emerging markets of China and Indonesia combining to make up more than one-third of the fund’s total assets. Because it is used heavily in industrial applications, coal often functions as a leveraged play on the global economy. If manufacturing activity picks up, expect KOL to get a nice boost (but also see Why GOOG Could Crush The Coal ETF).

Merrill Lynch Regional Bank (RKH) Beta=1.71

Some investors looking to avoid exposure to big Wall Street institutions that find themselves in the crosshairs of regulators have considered regional banks as an alternative play on the financial sector. But these smaller financial institutions have been incredibly volatile in recent years, with several being seized by federal regulators and exposure to bad loans weighing on the entire sector. RKH has a beta significantly higher than that of the iShares S&P Global Financial Index Fund (IXG) despite the fact that IXG has heavy allocations to names such as Bank of America (3.8%) and Banco Santander (2.23%).

A look at RKH’s holdings gives some clues to its volatility; this fund has a 22% allocation to J.P. Morgan and 20% to Wells Fargo (see more information on RKH’s holdings). Furthermore, the fund only contains 17 holdings and has more than 90% of its assets in the top ten holdings, suggesting a hit to any one of the top names will have an extremely large impact on the fund’s overall return. This is a good example of why investors should delve deeper into a fund’s holdings instead of just relying on the name of the fund to give hints about the exposure; RKH relies on large banks and has just 5.25% of its assets in banks that are medium capitalization or smaller (also see Ten Common Mistakes Every ETF Investor Should Avoid).

Market Vectors Steel Index ETF (SLX) Beta=1.79

Following the global recession in 2008, steel prices plummeted as car production and construction activity declined sharply. However, much like the overall economy, the steel industry began to pick up again earlier this year as robust demand from China buoyed the sector. Similar to KOL, this ETF serves as an effective way to establish leveraged exposure to the global economy. If manufacturing activity is on the rise, increased demand for raw materials translates into increased profitability for the steel industry.

Much like KOL, SLX has a heavy allocation to international stocks, which may be heavily contributing to its higher than expected beta. SLX allocates 65% of its assets to international firms with Brazil (22.6%), Luxembourg (14.5%) and the UK (11.9%) making up the top three allocations after the U.S. (also see What Every Investor Should Know About Commodity ETF Investing). One interesting fact about SLX is that it maintains a dividend yield of 3.4% (see more fundamentals of SLX here). It is extremely rare to see such a high dividend and a high beta in the same fund.

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Disclosure: No positions at time of writing