During the Great Recovery of the last 12 months, every sector of the U.S. and global economies have gained ground. But some industries have performed better than others, resulting in big performance gaps between various sector-specific ETFs. According to ETF Guide, the Vanguard Total Stock Market ETF (VTI) rose 28.8% but the technology sector SPDR (XLK) jumped 51.0% and the materials sector SPDR (XLB) soared by 48.5%. This shows that while picking the right asset class is crucial, picking the correct sector can have just as big an impact on total returns. For investors seeking help in choosing sectors that could outperform the general market, Claymore/Zachs Sector Rotation ETF (XRO) offers an interesting choice.
XRO tracks the Zacks Sector Rotation Index, which consists of equities that investment research firm Zacks believes offer a superior risk/return profile and could outperform the general market. The investable universe available to the index consists of the 1,000 largest listed equity companies based on market capitalization. This list, after using the proprietary methodology, is boiled down to 100 stocks that then comprise the index. The sector allocation methodology strives to overweight cyclical sectors prior to anticipated periods of economic expansion and overweight non-cyclical sectors prior to anticipated periods of economic contraction. It does this by using a bottom-up approach to decide on the weightings of each sector based on relative value, price momentum and earnings growth.
Exposure for any one sector may range from zero percent to a maximum of 45% of the index. Individual security exposure will be determined by relative market capitalization within the sector with no individual security making up more than 5% of the total index. The sector allocation and constituent ranking process is then repeated on a quarterly basis.
Currently, XRO is heavily allocated towards four sectors; computer & technology (35%), finance (25%), retail (21%), and consumer staples (10%). XRO gives smaller weightings to business services and consumer discretionary, which combine to make up roughly 3% of the total assets of the fund. XRO avoids concentrated exposure to any single stock, currently giving a weight of just 1.7% to top holding Amazon.com. But XRO’s holdings can change quite a bit from period to period as economic conditions evolve; one quarter’s overweight sector may be underweight the next.
Returns and Fees
XRO is up more than 8.9% to date in 2010, putting it well ahead of SPY on the year. But over the last 52 weeks however, XRO has lagged the broader market, delivering a return of about 40%. This ETF charges a slightly higher expense ration in exchange for the shot at alpha, and has volumes a little on the low side. About 5,000 shares are traded on average in a day, suggesting that limit orders are a good idea for those looking at making a play. If you’re looking for a more dynamic alternative to traditional cap-weighted ETFs, XRO might be worth a closer look.
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Disclosure: No positions at time of writing.