4 Sector Strategies for Your Portfolio
Ron DeLegge, Editor
April 11, 2011
Funds that follow specific industry sectors are the largest ETF category. And knowing which funds to choose is simply a matter of knowing what strategy you're trying to execute.
Let’s analyze four sector strategies:
One common method for investing in industry sectors is to buy funds or ETFs that own a basket of stocks within that sector. If you’re bullish, for example, on technology stocks, then owning the Technology Sector SPDRs (NYSEArca: XLK) is one way to participate. XLK owns just the technology stocks within the S&P 500.
Sector traders and investors will generally overweight – or own a larger percentage of whatever sector ETFs they like inside their portfolio. Conversely, they’ll underweight or avoid sectors they dislike.
Another sector strategy is called “equal weighting.” The stocks within these types of sector ETFs are assigned the same percentage within the portfolio so that larger stocks don’t skew the fund’s performance. Rydex offers a series of equal weight sector ETFs linked to stocks within financial (NYSEArca: RYF), energy (NYSEArca: RYE), healthcare (NYSEArca: RYH), industrials (NYSEArca: RGI), materials (NYSEArca: RTM) and utilities (NYSEArca: RYU).
The ALPS Equal Weight Sector ETF (NYSEArca: EQL) takes a novel approach by owning each of the Sector SPDR ETFs linked to nine S&P 500 industry sectors by 11.1 percent. Over the past few decades, the equal weighting strategy has experienced a performance advantage of 1 to 2 percent over traditional market cap weighted indexes.
Magnified exposure to industry sectors is possible two ways; 1) using margin within your brokerage account and 2) using ETFs that magnify daily performance by two or three times. The latter is often referred to as 2x and 3x ETFs.
Leverage is easiest explained with an illustration. For people familiar with cars, torque is analogous to leverage. Likewise, for cooks, chili peppers, which add zip to your dish, are just like leverage. In both cases, the idea is to greatly emphasize a certain thing.
The bulk of leveraged ETFs are offered by ProShares, which has mostly 2x products and Direxion Shares, which offers mostly 3x products. One example is the Direxion Daily Semiconductor Bull 3x Shares (NYSEArca: SOXL), which attempts to triple its daily performance.
What if you believe that commercial real estate or REITs (NYSEArca: VNQ) are headed for a fall? How could you potentially profit from that event? For super aggressive traders, one way would be to own a short or inverse real estate ETF like the Direxion Daily Real Estate Bear 3x Shares ETF (NYSEArca: DRV). DRV aims for daily triple opposite performance to REITs.
Less aggressive trades that bet on a decline in real estate are the ProShares Short Real Estate ETF (NYSEArca: REK) and the UltraShort Real Estate ETF (NYSEArca: SRS). REK offers 1x daily inverse exposure whereas SRS aims for 2x daily inverse exposure to real estate stocks.
Sector ETFs are great portfolio building tools. They can be used as core positions, secondary positions or as trading vehicles. Ultimately, it’s you the end user that will decide the best fit.
Finally, sector ETFs can also be excellent substitutes to individual stocks. Instead of betting on ExxonMobil (NYSE: XOM), for example, buying the Energy Sector SPDR (NYSEArca: XLE) gives you the same exposure to the energy group of which ExxonMobil is a part of. Using ETFs as single stock replacements is smart strategy that can reduce the higher risks of owning individual stocks.*
*See MCI Worldcom, eToys, Lehman Brothers, etc.