Specialized ETFs on rise
NEW YORK – Equity index funds are usually associated with the most passive form of investing: Buy one and you get quick, easy exposure to a broad swath of the market. But with the rise of specialized exchange traded funds, indexes are being used more often by active investors in increasingly complicated strategies.
With ETFs, which track indexes and are traded like stocks, investors can get inexpensive, tax efficient sector exposure while tilting their portfolio wherever it suits them. You could build your own version of the Standard & Poor’s 500 with Sector SPDRs – which divide the index’s nine sectors into ETFs – buying as much or as little of each sector as you like. If you don’t want to limit yourself to the S&P 500, you could buy the closely correlated Dow Jones U.S. sector indexes, which hold many more companies.
“This combines the benefits of index investing with a truly customizable approach to investing your money,” said Dan Dolan, director of wealth management strategies for Sector SPDRs. “You know exactly what you own, with a low cost, and you can do it with your own objective in mind.”
ETFs have been around since 1993, when the first one was created to track the S&P 500. Now there are more than 100 of them, and professional investors are finding new and novel uses for them all the time. ETF asset levels reflect their rising popularity: The Sector SPDRs held only $400 million when they were created in 1998; their assets had grown to $4.5 billion by last June, and now stand at $7.1 billion.
Still, with overall ETF assets totaling about $151 billion at the end of 2003, they make up only a fraction of the $7.4 trillion held in mutual funds.
The caveat with ETFs is that they’re expensive for people who regularly contribute to their investment portfolio, because trading costs are incurred each time new shares are purchased – not the case with most mutual funds. But for people considering allocation strategies for a larger nest egg, perhaps $100,000 or more, sector ETFs can offer some elegantly simple solutions.
In some scenarios, sector ETFs can be a tool for gaining greater diversity. Suppose you work for a large bank, and your spouse works for a software concern, and you both have stock options. Rather than owning a broad S&P 500 index, in which tech and financial stocks account for 42 percent of the whole, your financial adviser might suggest you get targeted exposure to other sectors of the market through ETFs.
Sector ETFs may also hold appeal for smaller investors who prefer to buy individual stocks rather than mutual funds. They could be useful if you have an idea or an opinion you’d like to act on. For example, if you think energy prices will stay high, or that health care will be a profitable business as baby boomers age, you could gain additional exposure through sector ETFs.
“If you have an investment idea that makes sense to you, not only do you have to be right about the idea, you have to be right about the stock you pick,” Dolan said. “For a small investor who has been beaten up by buying a few individual stocks, this is another way to do it.”