Similar Sector ETFs Not Built The Same

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

Not sure what to order at a new restaurant? While some may choose a couple of dishes that look familiar, others prefer ordering off a tasting menu. Similarly, investors and advisors increasingly use sector and industry ETFs as a replacement for individual stock positions.

According to State Street Global Advisors (SSGA), investors put $15 billion into sector ETFs through the first five months of 2017.

While the S&P 1500 Index was up 8.2% year-to-date through June 9, the gap between the best- and worst-performing sectors this year is wide. Gains of 18% for information technology and 13% for health care help mask the 13% and 9.5% losses for energy and telecom services, respectively, in a portfolio holding stakes in all 11 Global Industry Classification Standard (GICS) sectors.

By focusing on getting the sector calls correct, an investor can find performance success.

Pioneer Of Sector ETFs

SSGA pioneered sector ETF investing 19 years ago with the launching of then-nine Sector SPDR products, including the Financial Select Sector Fund (XLF) and the Health Care Select Sector SPDR (XLV). These products only hold S&P 500 constituents and are market-cap-weighted.

For example, Johnson & Johnson and J.P. Morgan Chase are heavyweights in XLV and XLF, respectively. Since then, SSGA added approximately two dozen industry-focused and typically equally weighted products, including the SPDR S&P Regional Banking ETF (KRE) and the SPDR S&P Biotech ETF (XBI), and a tenth Sector SPDR with the addition of a real estate product, the Real Estate Select Sector SPDR Fund (XLRE).

In ranking approximately 1,000 equity ETFs, CFRA leverages our qualitative stock research capabilities. Each ETF is ranked based in part by what CFRA thinks of the holdings inside from a forward-looking valuation and risk perspective rather than relying solely on past-performance metrics.

Sector ETF Assets

Relative to other large asset managers, SSGA’s asset base is more dependent on sector products, with approximately 25% of assets under management tied to these sector/industry offerings, according to our research. SSGA is the third-largest ETF provider.

Meanwhile, the second-largest provider, Vanguard offers just 11 sector/industry ETFs, but the firm has approximately 11% of total assets in these products. The Vanguard REIT ETF (VNQ), a $34 billion offering, is the largest, but the remaining 10 each have $1 billion or more in assets. Examples include the Vanguard Health Care ETF (VHT) and the Vanguard Financials ETF (VFH).

While VHT has a lower net expense ratio than XLV (0.10% vs. 0.14%), the 68 basis point performance differential in 2017, as of June 12, stems more from holdings differences. Vanguard’s sector products include some small- and midcap stocks outside of the S&P 500 Index and, as such, VHT has more biotech and less pharmaceutical exposure.

Popular Sector ETFs Offer Different Industry Exposure

Source: CFRA’s MarketScope Advisor

Different Sector Approaches

iShares is the largest ETF provider and has more sector/industry products for investors to consider. However, iShares’ sector/industry lineup is just 4% of assets, and assets are more concentrated in the industry products. The iShares Nasdaq Biotechnology ETF (IBB), at $8 billion, is the largest, while the iShares U.S. Financials ETF (IYF) and the iShares U.S. Aerospace & Defense ETF (ITA) are two of the 18 others that have more than $1 billion in assets.

In addition to generally having a higher net expense ratio than the SSGA and Vanguard competing products, the exposure provided by iShares is different.

For example, IBB is more concentrated in large-cap biotech stocks—such as Celgene and Gilead Sciences—than XBI. XBI outperformed IBB year-to-date through June 12 aided by success of smaller-cap companies such as Exact Sciences, a company focused on developing products for early detection and prevention of various cancers and that appreciated sharply in value this year.

Year-To-Date Performance Of XBI & IBB

Meanwhile, unlike peers XLF and VFH, IYF still holds a 20% stake in real estate companies, as the financial index it tracks was not impacted by the elevation of real estate as an 11th GICS sector. The portfolio also includes data processing and outsources services tech stocks Visa and MasterCard. We think these holdings differences help explain the outperformance thus far in 2017.

Charts courtesy of StockCharts.com

Fidelity Sector Suite Growing

Though the three largest ETF providers currently control 82% of total ETF assets, Fidelity has gathered nearly $5 billion in assets across its 11 sector ETFs since launching the series in October 2013. Fidelity sector products are similar to Vanguard’s—inclusive of large-, mid- and small-cap stocks within a sector—but currently charge 2 basis points less.

The Fidelity MSCI Information Technology Index ETF (FTEC) is the largest, at $963 million in assets, aided by $250 million of net inflows in the first five months of 2017.

Fidelity’s sector ETFs are not share classes of mutual fund portfolios and, as such, investors in FTEC will have a different experience than they would if they with Fidelity Select Technology Portfolio (FSPTX). For example the mutual fund holds some consumer discretionary stocks such as Tesla in addition to Apple and Facebook.

Other Industry/Sector Offerings

In addition, through products such as the First Trust Nasdaq Bank ETF (FTXO), the PowerShares Aerospace & Defense Portfolio (PPA) and the VanEck Vectors Retail ETF (RTH), investors have at least three ETFs to consider once they identify a sector or industry they think can outperform.

Rather than just selecting Fifth Third Bancorp, Northrop Grumman or Target, through CFRA hold recommendations, investors could use the above or peer ETFs to get a taste of what’s on the industry menu and gain exposure to what CFRA thinks are other more attractively value constituents.

At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him at @ToddCFRA.