Summing Sector SPDRS = SPY?

February 09, 2012

You’d think owning the nine sector SPDRs in proportion to their weightings in the S&P 500 is a way to recreate SPY (NYSEArca: SPY). But you’d be wrong.

That’s important because if you’re not market neutral—and therefore not inclined to simply buy SPY and be done with it as a means of achieving core equity exposure—you need to know that there’s a bit of the devil in the details if you try to tweak exposure using the sector funds.

Finding these quirks is why we’re always on the lookout at IndexUniverse for interesting thought experiments that can teach us things that might be important to investors and advisors.

To cut to the chase: There’s a good reason why the 10 sectors in the table below that comprise the S&P 500 get reduced to just nine sector funds. I’ll get back to the reasons for that.

Sector Weight as of 2/3/2012
Information Technology 19.63%
Financials 14.27%
Energy 11.92%
Health Care 11.64%
Industrials 10.96%
Consumer Staples 10.87%
Consumer Discretionary 10.74%
Materials 3.71%
Utilities 3.54%
Telecommunication Services 2.72%

 

But first, investors need to know that if they start piecing together the different sector SPDR funds to try to achieve some semblance of SPY (NYSEArca: SPY), weird things are going to start happening to their allocations of Exxon Mobil as well as Coca-Cola and General Electric.

Let’s start with Exxon.

The energy sector is so dominated by Exxon Mobil that the company’s weight is capped in the Select Sector SPDR energy fund, XLE (NYSEArca: XLE).

This means that if you owned all of the Sector SPDRs in percentages based on their relative sector weighting in the S&P 500 as shown above, you would own substantially less Exxon than you should based on the firm’s relative size.

The top 20 holdings of the S&P 500, and their weightings in our hypothetical Nine-SPDRS-Funds-Equal-SPY portfolio are shown below.

As you can see, Exxon isn’t the only company whose weighting changes in this reconstitution.

Holding Index Weighting Hypothetical Portfolio Difference
Apple Inc 3.5100% 3.07% 0.4379%
Exxon Mobil Corp 3.3400% 2.19% 1.1527%
International Business Mach 1.8700% 1.64% 0.2270%
Microsoft Corp 1.8600% 1.63% 0.2307%
Chevron Corp New 1.7200% 1.71% 0.0107%
General Electric Co 1.6500% 1.16% 0.4915%
Johnson & Johnson 1.4700% 1.49% -0.0176%
At&T Inc 1.4600% 1.28% 0.1821%
Procter & Gamble Co 1.4200% 1.47% -0.0518%
Pfizer Inc 1.3400% 1.35% -0.0126%
Wells Fargo & Co New 1.3300% 1.31% 0.0186%
Coca Cola Co 1.2700% 0.77% 0.4982%
Google Inc 1.2400% 1.08% 0.1564%
JPmorgan Chase & Co 1.1900% 1.18% 0.0099%
Berkshire Hathaway Inc Del 1.1500% 1.14% 0.0070%
Intel Corp 1.1200% 0.84% 0.2838%
Philip Morris Intl Inc 1.0900% 1.13% -0.0437%
Merck & Co Inc New 0.9600% 0.97% -0.0108%
Wal Mart Stores Inc 0.8900% 0.92% -0.0329%

 

General Electric and Coca Cola are both significantly underrepresented in this hypothetical portfolio, although the reason for this isn’t entirely clear. We’re still on the case though, and once we crack it, we’ll let readers know.

For now, we know that neither company is large enough to elicit capping rules in each fund’s respective sector, nor is either of those companies part of a sector that needed reweighting based on the diversification requirements of the Investment Company Act of 1940.

The bottom line is that the exposure an investor would get in this hypothetical portfolio is different than the exposure provided by SPY.

 

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