Sector By Sector In The S&P 500 With ETFs

[Editor’s Note: This article was one of ETF.com's most popular of 2021.]

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Craig Israelsen, Ph.D., creator of the 7Twelve portfolio, consultant to 7Twelve Advisors, LLC and executive-in-residence in the Financial Planning Program at Utah Valley University. 

The S&P 500 Index comprises 11 nonequally weighted sectors as shown in the table below. As of Dec. 31, 2020, the most heavily weighted sector (by far) was information technology, at 27.6%. Next was health care, at 13.5%. The smallest weighting was in energy, at 2.3%. Also included in the table are ETFs at Vanguard and State Street that attempt to more or less replicate the performance of each sector.

Sector Allocations in the S&P 500 Index
As of 12/31/2020

The 73 individual stocks in the S&P information technology sector determine 27.6% of the return of the S&P 500 Index. Said differently, 14.5% of the 505 stocks in the S&P 500 Index determine nearly 28% of the performance.

Clearly, the performance of companies in the sectors of information technology, health care, consumer discretionary and communication services exert a much greater impact on the performance of the S&P 500 Index than companies in the utilities, real estate, materials and energy sectors. This is a natural result of building an index that is market capitalization weighted.

The Vanguard sector ETFs track MSCI sector indexes, while the SPDR sector ETFs track S&P sector indexes. The total number of holdings in the 11 Vanguard sector ETFs was over 2,560 as of Dec. 31, 2020, whereas the 11 SPDR sector ETFs had a total of 518 holdings. Thus, the SPDR sector ETFs are generally closer to replicating the actual S&P 500 Index in terms of total number of holdings.

The challenge in using the SPDR sector ETFs in this analysis is that two of them (XLC and XLRE) were not in existence over the full 16-year period from 2005-2020. Thus, I’ll focus on the Vanguard sector ETFs, because all 11 of them have a performance history back to 2005.

It’s worth noting that, despite the difference in total number of holdings, the performance of the 11 Vanguard sector ETFs and the 11 SPDR sector ETFs were relatively similar in 2020, as shown below. The one exception is in the consumer discretionary sector. VCR had a return of 48.22%, whereas XLY had a return of 29.66%.

Drilling Down

Let’s now take a look at the performance differences among the various sectors over the past 16 years (using the performance of the Vanguard sector ETFs).

As shown in the table below, the best-performing sector over the past 16 years (Jan. 1, 2005 to Dec. 31, 2020) was information technology (symbol VGT), with a 16-year average annualized return of 14.45%. (These 11 Vanguard sector ETFs all began in 2004, but the first full year of performance was 2005.) For comparison, the Technology Select Sector SPDR Fund (XLK) had a 16-year average annualized return of 13.63%.

Annual Returns of S&P 500 Sectors from 2005-2020
3 Best-Performing Sectors Highlighted in Gold

The next best performer was the Consumer Discretionary ETF (VCR), at 11.99%. At the top of the table is the performance of the S&P 500 Index as represented by Vanguard S&P 500 ETF (VOO). Its 16-year return was 9.51%.

The annual returns of the Vanguard 500 Index Fund (VFINX) were used for the years 2005-2010. because the first full year of performance for VOO was 2011. VOO and VFINX have identical portfolios inasmuch as they both track the S&P 500 Index.

The gold highlighting in the table indicates the three best-performing sectors each year. In the far-right column, the three best-performing sectors over the past 16 years are highlighted.

S&P 500 Exposure: 1 Or 11 Tickers?

It is certainly convenient to invest in the S&P 500 by using one ticker (an ETF or mutual fund that mimics the index). However, the performance of that one ticker represents the aggregate return of all 11 sectors. It is not possible to withdraw money from the best-performing components (sectors) of the index. To do that, you would need to invest in each sector separately, which is easily done by the use of sector ETFs.

As shown in the table above, the advantage of building your own S&P 500 exposure by using sector funds is that you can withdraw money from the best-performing sector(s) at the end of each year (if withdrawals are needed).

For example, in 2005, had you invested in the S&P 500 as a whole (such as with VFINX or another S&P 500 Index fund), your return was 4.77%. If you needed to make a withdrawal, it would have been a withdrawal based on the fund’s return of 4.77%.

Alternatively, had you invested in all 11 sector ETFs, your withdrawal could have been made from the three best-performing ETFs. In 2005, the best-performing sectors were energy, with a return of 39.05%; utilities, with a return of 14.75%; and real estate, with a return of 12.00%.  

Using a sector approach, you have 11 buckets from which to withdraw money rather than just one. After each year is over, and the performance of all the sectors is known, we would naturally withdraw money from the buckets that had the highest returns. The number of “buckets” from which you would withdraw money each year is up to each individual.

As always, it’s your call.

Contact Craig Israelsen at [email protected]