Exchange traded funds allow investors to capture broad markets. However, investors should be mindful of what ETFs they pile into as layering the investments may inadvertently overweight a portfolio to a market segment.
“When you purchase an ETF, you might end up with more or less than you bargained for due to the variety of factors that comprise the fund,” writes Scott Kubie, chief strategy officer at CLS Investments, for InvestmentNews. “Your portfolio can become overexposed in a manner you didn’t intend because the type of ETFs you purchased brought additional exposures along with them.”
CLS Investments points out that investment portfolios are beginning to tilt toward larger allocations in consumer staples and health care stocks. While these defensive sectors have performed in recent years, there is no guarantee the outperformance will last.
Consequently, investors should monitor their exposure, especially with broad stock ETFs. To start off, many include a core position in the S&P 500, which allocates about 15% in healthcare and a little over 9% in consumer staples – the SPDR S&P 500 ETF (NYSEArca: SPY) includes 15.5% health care and 9.5% consumer staples.
Additionally, ETF investors should monitor their other portfolio holdings to check for potentially overweighting the two sectors. For instance, the two sectors tend to be steady businesses that are more likely to regularly increase dividends. Consequently, dividend growth ETF may hold a larger position in the two sectors. The Vanguard Dividend Appreciation ETF (NYSEArca: VIG), the largest dividend ETF, includes a 15.0% tilt toward health care and a large 24.5% position in consumer staples. [Like Dividend Growth? You’ll Love These ETFs]
Due to the outperformance of the two sectors, momentum strategies that emphasize good performance over the intermediate term have also jumped on the bandwagon. For example, the First Trust Dorsey Wright Focus 5 ETF (NasdaqGM: FV), the largest momentum-based ETF, holds 26.9% biotech, 20.8% health care and 17.1% consumer staples. [A Relative Strength ETF With, Well, Relative Strength]
Since health care and consumer staples have traditionally acted as more defensive sectors, the two areas also make up large positions in low volatility investment strategies. The iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) includes 20.4% healthcare and 14.2% consumer staples. [ETFs to Play the Market During More Volatile Conditions]
International stock ETFs may also include a heavier emphasis on health care and consumer names. For instance, the iShares MSCI Switzerland Capped ETF (NYSEArca: EWL) has 32.2% in health care and 18.6% in consumer staples.
With ETFs, investors should be careful with their overall allocations, especially when targeting specific themes. For example, investors who want to emphasize value will likely find themselves overweight banks and the financial sector, which shows some of the cheapest price-to-earnings relative to other sectors.
Alternatively, investors can utilize targeted sector ETFs to bolster underweight areas.
“The easiest step is to buy targeted ETFs to increase allocations to particular sectors,” Kubie added. “For example, if the strategies above are favorites, then you can purchase sector ETFs to cover gaps in the portfolio. Buying a technology or financial sector ETF may offset the extra emphasis to consumer staples and health care.:
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.