How Advisors Evaluate Industry, Sector ETFs

Last week in this space, citing data from State Street Global Advisors (SSgA), the expected growth of sector and industry exchange-traded funds were highlighted.

SSgA, the third-largest U.S. ETF issuer and the largest sponsor of sector ETFs, recently polled nearly 420 advisors and wealth managers regarding their use of sector and industry ETFs. While the findings vary, the overall tone bodes well for the current and future growth of sector and industry funds. As was noted, 16 of the 100 largest ETFs by assets on the market today are sector or industry, a group including well-known fare such as the Health Care SPDR (ETF) XLV.

Use Of Sectors/Industry ETFs

SSgA data suggest many respondents to the survey use sector or industry ETFs for tactical exposure or as satellite positions. However, some money managers use sector and industry funds to complement core equity exposure and as a way of generating low-cost alpha.

Related Link: A Smart ETF Play On A Dependable European Market

While changing market environments and other factors lead advisors and money managers to and from sector and industry ETFs, there are factors professional investors take into account when selecting from this genre of ETFs.

SSgA's survey indicates 83 percent of respondents are using both sector and industry funds. Examples of well-known industry ETFs include the SPDR S&P Biotech (ETF) XBI and the SPDR S&P Homebuilders (ETF) XHB.

A primary use of sector ETFs is for tactical exposure, an objective that is enhanced and refined via industry ETFs. For example, investors might be pleased with the returns of The Industrial Select Sector SPDR Fund XLI year-to-date, but presidential election posturing has been a potent driver of alpha for the SPDR S&P Aerospace & Defense ETF (SPDR Series Trust XAR).

Loving Liquidity

Not surprisingly, SSgA data indicate users of sector and industry ETFs prize liquidity and fees above other factors, though the ETF's holdings, index provider and weighting methodology, among other factors, are also considered important.

“Methodology is always worth a closer look as certain exposures may not offer the exposure you seek and understanding the differences among indices can help achieve the most precise exposure,” added SSgA.

Equal weighting is perhaps the most popular weighting methodology aside from cap weighting among sector and industry, but in recent months, some ETF issuers have launched multi-factor sector offerings. The aforementioned XAR, XBI and XHB are examples of equal-weight industry ETFs. The largest sector ETFs, such as XLV, are usually cap-weighted funds.