Sector funds are a temptation few investors can resist. With investment-oriented websites and cable news programs now unleashing a constant barrage of data regarding housing starts, retail sales and oil inventories, it seems like second nature to fine tune any portfolio with allocations to various industries or economic sectors that appear poised to grow (or contract) over the coming years.
Sector funds offer investors exposure to a specific industry or sub-industry, while minimizing “company risk,”–the potential for shares in a company to fall while others in the same industry are rising due to company-specific factors. They don’t always follow general trends in the stock market, and are often considerably more volatile.
Hundreds of mutual funds already exist, offering exposure to different sectors of the U.S. and global economy, and the number of exchange traded funds set up to track sector indexes is growing quickly. There were 233 “sector/industry” ETFs trading at the end of April, 2009, according to Investment Company Institute data, more than the 201 broad-based equity funds or the 211 global or international equity funds.
Sector ETFs have both advantages and disadvantages compared with similar mutual funds. Like other ETFs, their expense ratios tend to be very low, usually from 0.4% to 0.7%, compared to a range of 0.7% to more than 2.0% for sector mutual funds. Also, since they trade all day long, sector ETFs can be bought and sold in reaction to new market data–which is usually released early in the day–while mutual fund transactions are given an end-of-day price.
The massive upheaval in the banking sector helped land three financial sector ETFs: Direxion Daily Financial Bull 3X (FAS), Financial Select Sector SPDR (XLF), and Direxion Daily Financial Bear 3X (FAZ), in the top five among trading volume for ETFs over the past three months, according to Yahoo data. (Leveraged sector ETFs, such as FAS and FAZ, have important differences from unleveraged sector ETFs that may affect returns significantly. S&P will write more about that subject in this space next month.)
Real estate sector ETFs have been extremely popular recently, as a means for investors to place bets on the future of the U.S. housing market.