There is no doubt about it. Investors love sector exchange traded funds. As of mid-March, health care ETFs had raked in $1.8 billion since the start of the year and that is just one example.
In March alone, investors poured $1.5 billion into financial services ETFs, nearly $940 million into technology funds and nearly $900 million into ETFs offering exposure to the materials sector. [Sluggish Quarter of ETF Inflows]
The popularity and accessibility of ETFs is important, but so is taking the time to understand that just because two ETFs have “health care” or “energy” in their titles, that does not mean those funds are mirror images of each other.
“Investing in technology, health care, the financial industry and other segments of the U.S. stock market is riskier than owning funds that take a more diversified approach. How much riskier depends on which funds you buy in the sector you favor,” writes Jonathan Burton for the Wall Street Journal.
Burton notes that sector ETFs can be classified by three categories, beginner moderate and advanced. The Journal uses health care as an example and why not. As of the end of February, more than half the money investors had allocated to sector ETFs this year had gone into health care funds. [Plenty of Cash Going Into Health Care ETFs]
The Health Care Select Sector SPDR (NYSEArca: XLV), the largest health care ETF by assets, and the rival Vanguard Health Care ETF (NYSEArca: VHT) are examples of beginner level health care ETFs. But even with these two funds, investors should spend a few minutes studying what drives performance. As the Journal notes, both XLV and VHT are heavily allocated to blue chip pharmaceuticals names like Pfizer and Merck, but VHT has deeper exposure to mid- and small-cap stocks, an important driver of that ETF’s returns. [Health Care ETFs Assert Leadership]
An example of a moderate level sector ETF as highlighted by the Journal is the First Trust Health Care AlphaDEX Fund (NYSEArca: FXH), which eschews the cap-weighting methodology of XLV and VHT. FXH’s holdings are selected based on “growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets,” according to First Trust.
That methodology has worked for FXH, helping it gain almost 32% in the past year while being on of the most prolific asset gatherers in the First Trust lineup.
“The riskiest of a sector’s ETFs are the most narrowly focused. They are potentially the most lucrative, even though their expenses tend to be higher than those of more broadly based sector ETFs. But their tight focus makes them more volatile,” according to the Journal.