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Customizing Portfolio Exposure to the S&P

Customizing Portfolio Exposure to the S&P

December 12, 2008


SAN DIEGO ( – In the good old days, people would go to a restaurant and order a whole pie. Today, people can go to the same restaurants and order individual pieces and enjoy their favorite slice. A similar thing has happened in the burgeoning exchange-traded fund (ETF) business.


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


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? interviews Dan Dolan, Director of Wealth Management Strategies at the Select Sector SPDRs. Dolan talks about the market’s performance and shares his thoughts about the benefits of sector investing.


Given 2008's financial chaos, the sector representation of the S&P 500 has changed dramatically this year. Tell us about this.


DD: The market is on pace to establish 2008 as the worst year ever as measured by the S&P 500 (AMEX: SPY). Down 40%+ is unprecedented since the index began in 1957. You have to go back to 1931 to find the market down more than 40%. The financial sector has clearly led the way down, off almost 60% but all sectors are down for the year. The only sector down less than 20% is consumer staples. In fact, staples' out performance has been so strong its weighting has increased 35% to almost 14% of the S&P 500. Historically defensive sectors like healthcare and utilities have also seen their relative weighting increase in 2008. In addition to financials, the materials and consumer discretionary sectors have seen their weightings slip as a result of under performance.


The Consumer Staples (NYSEArca: XLP) have been the best performing S&P sector this year. Wal-Mart (NYSE: WMT), which is part of this group, posted 3Q earnings 9.8% higher. Why are Staples holding up?


DD: Wal-Mart, the second largest component of the consumer staples sector after Proctor & Gamble (NYSE: PG) is a strong performer in 2008. Staples should do well is this very difficult environment. Consumers will continue to buy their necessities regardless of economic activity. Many will continue to buy beer, smoke their cigarettes, brush

their teeth and wash their clothes no matter how bad things get. Corporate profits are more predictable in this sector.


What other industry sectors tend to do better during a recession or slow economic growth?


DD: The other two defensive sectors that should continue to do relatively well in this environment are healthcare (NYSEArca: XLV) and utilities (NYSEArca: XLU). Consumers will do everything they can to maintain their health and keep the lights on. Most will stop all discretionary spending before touching monies set aside for these necessities. Again, earnings in healthcare and utilities are far more predictable.


Does this year's rout in Financials (NYSEArca: XLF) at all remind you of the rout in Technology (NYSEArca: XLK) back in 2000-02?


DD: The rout in the financial sector this year is reminiscent of the damage done to the technology sector in 2000-2002 but I believe it is even more painful. In 2000, we all knew stocks couldn't continue to double monthly and revenue and earnings would be important again some day. Financials had strong earnings, revenues and even dividends. They

were the classic "blue chips". We didn't expect to double our money instead we were looking for single digit growth, a dividend and a solid total return. It all changed 18 months ago and very few financial companies were spared.


2008 will go down in history as the year that bombed buy-and-hold mutual fund investors with one of the largest tax bills ever. What can be learned from this?


DD: Taxable distributions paid to investors this year will cause more pain than ever. After suffering through such a brutal year, paying taxes on a gain due to another investor's redemption is just rubbing salt in the wound. The tax inefficiency of the traditional mutual fund will be exposed and hopefully force investors to find better investment structures. ETFs will likely pay minimal, if any, distributions this year and offer investors the ability to better control their own tax liabilities.


With over 200 industry sector funds, this particular category of ETFs is easily the largest. How do the Sector SPDRs stand out?


DD: Sector SPDRs are the largest and the most liquid sector ETFs offered in the U.S. With assets of $25 billion and average daily trading volume of more 240 million shares per day, they are clearly the choice of institutional investors. The 23 basis point expense ratio and the 1 penny wide spread on all 9 make buy and selling Sector SPDRs the low cost

solution in the category.


What are a few pointers for people to consider before investing in a sector ETF?


DD: Investors should consider how sector ETFs may fit in their portfolios. Will they be a stock or mutual fund alternative, a core position or satellite? Are you increasing or decreasing the overall risk in the portfolio. Are there one or two driving forces that move an entire industry or sector, i.e. the price of oil/gas and the energy sector? Once you establish investing in sector ETFs is appropriate, investors have many choices and should evaluate the different offerings in the category. Issues like the index, expenses, trading spreads, size of order, tax efficiency and liquidity all should be examined to find the best in class.  Sounds complicated but it's not - the answer is usually very obvious.


Thanks Dan.


More information can be obtained including a prospectus by visiting or calling 800-843-2639     

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