Smart Beta Tech ETFs Offer Different Tilt

Higher weightings of semiconductor firms may prove smart this earnings season.

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

As earnings season kicks off, investors will be closely watching the U.S. technology sector. Expectations for strong results are high. However, ETF investors will want to understand the industry-exposure differences of products they own or are considering owning, since not all tech companies have the same fundamentals.

Heading into the first-quarter 2017 earnings season, the S&P 500 information technology sector was expected to report earnings growth of 16.2%, according to S&P Capital IQ consensus estimates as of April 12. That represents the highest growth in the index after energy and ahead of the S&P 500's 9.7%.

While energy is projected to bounce back from a prior loss, technology is likely to be a top-three growth leader for the S&P 500 Index for the third quarter in a row, according to Lindsey Bell, an investment strategist at CFRA Research.

Bell highlights that the semiconductor/semiconductor equipment industry is likely to be the driver in the first quarter, with a 39.4% projected growth rate. CFRA equity analysts cover 54 U.S. stocks within the industry and have 24 strong buy or buy recommendations. Other industries expected to experience double-digit growth for the quarter include internet software and services (28.3%) and electronic equipment and instruments (18.8%).

Source: Capital IQ, April 12, 2017

The Technology Select Sector SPDR Fund (XLK) and the Vanguard Information Technology (VGT) are the two largest technology-focused ETFs, with $17 billion and $12 billion in assets, respectively. However, there are holding differences between them. XLK has some telecom exposure, while VGT has more small- and midcap exposure.

Yet both these market-cap-weighted ETFs have a double-digit percentage of assets in CFRA strong-buy-recommended Apple. As such, a hefty ~17% of assets are weighted to the technology hardware, storage and peripherals industry because of Apple's size, regardless of its other fundamental attributes.

The Guggenheim S&P 500 Equal Weight Technology ETF (RYT) holds 67 S&P 500 tech stocks, but rather than being dominated by Apple and other tech heavyweights such as Microsoft and Facebook, RYT has a roughly equal weighting in more moderately sized tech companies.

For example, semiconductor and semiconductor equipment companies (22% of recent assets) were well represented, including Broadcom and KLA-Tencor, and comprised a larger weighting than technology hardware storage & peripherals (11%). RYT has a 0.40% net expense ratio and $1.2 billion in assets.

While the PowerShares DWA Technology Momentum Portfolio (PTF) is also rebalanced on a quarterly basis, it aims to identify tech companies that are showing relative strength and is reconstituted every three months. Here as well, semiconductor and semiconductor equipment companies were more exposed (28% of assets) than technology hardware, storage and peripherals (12%), but stocks are not equal in positioning.

Advanced Micro Devices and Micron Technology were among the top-10 holdings, with recent weightings of 4.3% and 2.6%, respectively. Apple was the largest holding, at 5% of assets. PTF, which tracks a Dorsey Wright index, has a 0.60% net expense ratio and $130 million in assets.

Exposure To Semis Higher At Fundamental ETFs

Source: CFRA Research, March 2017

In contrast, and using an index designed by DFA, the John Hancock Multifactor Technology ETF (JHMT) combines size, value and quality attributes to build its portfolio. Semiconductor and semiconductor equipment companies (24% of assets) are again higher than technology hardware, storage and peripherals (12%), with Intel, Qualcomm and Micron Technology among the top 10 holdings. However, Microsoft and Apple were the two largest holdings. JHMT, which is rebalanced on semiannual basis, has a 0.50% net expense ratio and $40 million in assets.

Of course, investors who want to focus solely on the semiconductor and semiconductor equipment industry could look to industry specific products, including the iShares PHLX Semiconductor ETF (SOXX) or the SPDR S&P Semiconductor ETF (XSD), but they would miss out on the diversification benefits in case analysts are incorrect about the industry leading the sector's earnings this season.

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