The Changing Face Of Sector ETFs

April 07, 2016

[This article appears in our May issue of ETF Report.]

Exchange-traded funds that exclude some sectors and funds that use smart-beta factors are part of several new and notable sector-related ETF launches. Unique takes on the sector space are often few and far between—2014 saw only a scattered handful—but over the past year or so, there has been what seems like a burst of such funds.

Last year, ProShares released several S&P 500 ETFs that exclude single sectors—such as ex-financials—in September, while John Hancock teamed up with Dimensional Advisors to launch four smart-beta sector funds at around the same time, followed by another five in March 2016.

Another heavy-hitter name, State Street Global Advisors, also launched two new Select SPDR ETFs, the Financial Services Select Sector SPDR (XLFS) and the Real Estate Select Sector SPDR (XLRE), which divide its popular Financial Select Sector SPDR (XLF | A-92).

Plus, there are a handful of stand-alone ETFs focused on certain industries like utilities and health care.

Despite having some unique strategies or compelling themes, according to some industry watchers, many of these new sector-related ETFs are having difficulty attracting assets. Granted, new funds may get off to a sluggish start, and 2015 saw a near-record number of launches, which may have led to more competition. A volatile stock market may also have had an impact.

“Generally, when market conditions are positive, you’ll see more sector-type products, because people are more interested in digging in. When market conditions are worse, it’s harder to launch those products, because people are less likely to get out of core exposure,” said Christian Magoon, chief executive officer of Amplify Investments.

ProShares S&P Ex-Sector Funds

Of the new sector-based releases, Magoon and Paul Britt, senior analyst at FactSet, said the ProShares S&P 500 sector funds omitting certain sectors seem to be the most unique. The four funds—S&P 500 Ex-Energy (SPXE), the S&P 500 Ex-Financials (SPXN), the S&P 500 Ex-Health Care (SPXV) and the S&P 500 Ex-Technology (SPXT)—offer core exposure to the broader market, except for certain sectors.

“I’m a fan, with respect to the structure. They make sense,” Britt said.

He added these funds could benefit investors with a large exposure to certain sectors because they work in a particular industry and may already have a lot of company stock.

Magoon said he’s “really intrigued” by these ETFs.

“To be able to invest in the S&P and eliminate that energy sector is really appealing, based on where that sector is and the outlook for it, even if it’s just to eliminate the uncertainty,” he added.

He sees these as a way to hedge or express an opinion on a market segment, especially since big moves in the S&P 500 often are caused by individual sectors. These ETFs give advisors the opportunity to avoid more volatile sectors without having to create separate trades, like shorting options.

However, these funds haven’t seen a great deal of interest yet, despite the good concept, which is surprising, Britt says.

“Maybe the problem for traders is this is the basket that they aren’t trading. So if we think about traders driving the shorter-term-type stuff, and driving a lot of the order flow, then this basket is by definition not trading,” he noted.

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