The S&P 500 ETF (SPY) may be the most popular ETF as measured by assets and trading volume but sector and industry ETFs are where many financial advisors are looking to gain an edge.
A new survey of advisors and wealth managers by State Street Global Advisors (SSGA), which created the first equity-based ETF in the U.S. in 1993 followed by SPDR sector ETFs in 1998, found that 85% of respondents are using sector or industry ETFs; many for a large chunk of portfolios. One-quarter are using sector or industry ETFs for more than one-fifth of their portfolios.
State Street surveyed 419 investment professionals between late 2015 and early 2016. Thirty-four percent were RIAs; 30% national or regional broker-dealers; 27% independent broker dealers; and the remainder were primarily private wealth managers or family.
These advisors and wealth managers are using sector ETFs for diversification, tactical advantages, obtaining alpha and managing risk, in that descending order, according to the survey.
“The lower-for-longer return environment has many investment professionals taking a more precise approach to asset allocation, which favors sectors and industries over style-based investing,” said Nick Good, co-head of State Street’s Global SPDR business, in a statement. Style-based investing refers to growth and value as well as small, mid- and large-cap stock investments.
Good explained that from 2000 to 2015, the average annual difference between the performance of large-cap growth and value stock stocks was less than 8% while the average difference between the best-and worst-performing sectors was 36%.
“In such periods of generally uncertain markets, sector and industry investing may offer the potential to add excess returns,” the survey notes.
Take 2015, when the S&P 500 gained just 1.38% for the year but the consumer discretionary sector advanced by more than 10%, led by a surge in internet and catalogue retailer stocks. This particular sector, like most, is comprised of multiple industries.
And over the past 17 years, the average correlation of the broad S&P 500 to growth and value has been close to 100% while the average sector correlations to the broad market have ranged between 0.60 for utilities to 0.92 for industries.
Clearly sector and industry ETFs can potentially provide advisors a potential competitive advantage compared to the broader market.
When asked their reasons for investing in sector ETFs, just over half of advisors surveyed cited a change in market conditions and 22% referred to “third-party guidance,” from a product provider or industry expert. Nine percent cited their investment model and 8% noted the positive returns they had earned from the same ETF in another portfolio.
As for choosing among the many sector and industry ETFs, advisors cited liquidity, expense ratios and portfolio holdings as the most important criteria.
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