The inflows into dividend focused exchange traded funds have revealed that certain income investments are concentrated in a few sectors. This can throw off the balance of a portfolio if an investor ignores the details.
“It’s not surprising that dividend-seeking strategies have a tendency to be biased toward certain sectors, particularly those in which the majority of constituent companies have historically paid dividends. This was also true in the years leading up to the recent financial crisis, when it was not uncommon for equity income ETFs to allocate approximately half of their portfolio holdings to the financial sector,” Ryan Issakainen for AdvisorOne wrote. [Sector ETFs to Play Defense]
The risk of over allocation to one sector or another is evident these days and more investors are aware of this. However, should an investor not look at the holdings within a chosen ETF, over allocation can be a problem. This is a good example of why it is important to look at what sectors and stocks are heavily represented in an ETF before putting money into one. [Death of Dividend ETFs ‘Greatly Exaggerated]
Most sector ETFs of today are usually overweight or underweighted to a certain area of the market or single company. For example, many dividend income strategies are overweight in the utilities or consumer staples sectors, which are also classic defensive plays. Issakainen points out that in comparison to the S&P 500, the five largest equity income ETFs, by assets, are overweight in the utility sector by 10 points and by 9 points in the consumer sector. [Dividend Stocks, ETFs Could See Higher Payouts]
A sector that is constantly underweight in income strategies is information technology. The same 5 equity ETFs measured for overweighting sectors were studied and only about 5% is allocated on average to the IT sector. This is important because over the past 5 years, dividend payouts from this sector have grown at a 21% annual rate. Currently, this is also the largest contributor of dividend payouts for the S&P 500. [ETF Investing Ideas for 2013]
One solution for under-allocation to a specific sector can be found simply by investing in the focused sector ETF. The first step is realizing what exposure a portfolio needs and to be aware of any over exposure, for proper asset allocation.
Tisha Guerrero contributed to this article.