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Can Sector Investing Help Your Portfolio?

Can Sector Investing Help Your Portfolio?

October 7, 2008

 

SAN DIEGO (ETFguide.com) – Customization has become a huge business and no where is this trend more apparent than with exchange-traded funds (ETFs).

 

Today, investors can get precise market exposure to countries, currencies, and industry sectors that were out of reach just a few short years ago.

 

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Introduced back in 1998, the Select Sector SPDRs are the earliest industry sector ETFs to be launched. And judging by the massive trading volume and billions in money flow, the interest and demand for these types of funds is strong.  

 

How can sector ETFs help you to manage your portfolio more effectively? And which sectors might perform better than others, despite the dim prospects of a global recession? What factors should you consider before choosing a sector ETF?

 

Jeremy Held of ALPS Distributors shares his thoughts about the sector investing.

 

What’s the purpose of exchange-traded funds (ETF) that follow industry sectors?

 

JH: Sector ETFs are very useful investment vehicles because they satisfy an investor need that is not covered well by either mutual funds or stocks.  That is the need for concentrated diversification.  Investors can use Sector ETFs to get access to attractive investment themes, such as Energy (AMEX: XLE) or Health Care (AMEX: XLV), in a way that is much more precise than what they can typically get with mutual funds.  On the other hand, Sector ETF investors avoid single-stock risk because each ETF contains a number of stocks within each sector.    

 

Talk specifically about the Select Sector SPDRs. How are they different from other sector ETFs?

 

JH: The Sector SPDR ETFs break up the S&P 500 Index (AMEX: SPY) into its sector components.  In the aggregate the Sector SPDRs represent the whole S&P 500, but by owning the pieces investors can customize the S&P to meet their own objectives.  In addition, the Sector SPDR ETFs are among the cheapest and most liquid ETFs not only in the Sector ETF category, but also in the entire ETF universe.  These features allow Sector SPDR investors to customize their US large cap exposure in a very cost-effective manner.   

 

In your latest white paper titled, “Don’t Get Mad, Get Even”, you illustrate how industry sectors can greatly influence performance. Can you give us any examples of the negative impact that uneven sector exposure can cause?

 

JH: The last three sustained double-digit market declines in the S&P 500 were all precipitated by a bubble bursting in the largest sector of the S&P 500 (Energy - 1981, Technology - 2000, and Financials - 2007-08).  In each of these time periods the largest sector of the S&P approached 30% of the entire index.  By simply monitoring sector exposure investors can go a long way toward mitigating some of the risks in the market. 

 

Why does having equal weight market exposure to industry sectors make sense and how can it be achieved?

 

JH: Sector leadership changes frequently and is very difficult to predict.  Weighting the sectors equally in a portfolio provides investors with enough exposure to every market sector so that they can participate in a rally wherever it occurs.  At the same they minimize the negative impact of being overexposed to the wrong sector at the wrong time.  The simplicity and transparency of the strategy also lends itself to tactical asset allocation - because investors know exactly what their sector exposure is they can easily add and unwind individual sector positions on top of an equal sector core.

 

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This year a lot of attention has been focused on poorly performing industry sectors like financials. In contrast, what sectors are holding up?

 

JH: Although most of the focus has been on the carnage of the financial sector and the volatility in the natural resources sectors (Energy and Materials (AMEX: XLB), underneath it all we are seeing the typical defensive sector rotation that accompanies a market slowdown.  Over the last year Consumer Staples (AMEX: XLP) has outperformed the S&P by more than 20% and is the only sector in positive territory.  Another defensive sector, Health Care, has been the best performer over the last three months and is third, just behind Energy, over the last 12 months. 

 

Before buying a sector ETF, what sort of factors or criteria should investors consider?

 

JH: The biggest differentiator among sector ETFs is the market cap exposure that is being provided.  Several sector ETFs provide exposure to the large cap segment of the market while others focus primarily on small or mid cap exposure. In addition, within the large cap category there are large differences in both expenses and liquidity.  Investors should consider all of these factors before making an investment decision. 

 

Thanks Jeremy.

 

Jeremy Held is a Registered Representative of ALPS Distributors, Inc.  ALPS Distributors, Inc., a registered broker-dealer, is the distributor for the Select Sector SPDR Trust. More information can be obtained including a prospectus by visiting www.sectorspdrs.com or calling 800-843-2639     

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