By Todd Rosenbluth, CFRA
Despite a pullback in June, technology investments have been among the strongest sector performers in 2017. For example, shareholders in many popular tech ETFs are experiencing double-digit returns, riding the gains of Alphabet (GOOGL), Apple (AAPL) and Facebook (FB). However, investors in active strategies focused on the same style have done better than their passive alternatives aided by flexibility.
Technology Select Sector SPDR (XLK 55 Overweight), a $16 billion ETF, was up 14.7% year to date through July 7, ahead of the 9.3% gain for SPDR S&P 500 (SPY 242 Overweight). In the first quarter the S&P 500 technology sector generated 23% earnings growth and S&P Capital IQ Consensus forecasts predict 11% growth for pending second quarter results, better than the 6% average for the broader index.
Yet, XLK does not exactly track the S&P 500 technology sector. While it includes the S&P 500 tech sector constituents, it also includes the four S&P 500 telecom services stocks in its Select Sector index. Hurt by AT&T (T) and Verizon Communications (VZ), the telecom sector of the S&P 500 declined 13% in the first half of 2017.
Inclusion of telecom stocks partially helps explain the performance differential between XLK and Vanguard Information Technology (VGT), a $13 billion peer ETF, but one that holds on tech stocks. VGT’s 17.3% gain was also aided by small- and mid-cap tech stocks such as Cognex (CGNX) and Ultimate Software (ULTI). While eye-catching, CFRA does not believe VGT’s four basis points of expense ratio savings provided much of a boost, as VGT was ahead by 260 basis points in 2017.
However, the average mutual fund in Lipper’s Science & Technology peer group was up 19% year to date through July 7, ahead of passive alternatives. As we noted in a Trends & Ideas article published last week “IT’S HALFTIME AND ACTIVE FUNDS HAVE GROUND TO MAKE UP,” diversified large-cap core mutual funds lagged the S&P 500 index in the first half.
Though the name suggests the sector focused mutual funds can regularly include health care and tech stocks, many of the top performers this year have shined by including consumer discretionary and international tech stocks along with AAPL and GOOGL.
Fidelity Select Technology Portfolio (FSPTX) was the best performer of the mutual fund peer group, climbing 28%. In addition to the aforementioned U.S. tech heavyweights, manager Charlie Chai holds stakes of automaker Tesla (TSLA) and Chinese e-commerce company JD.com (JD) within its top-10 holdings. FSPTX’s 0.77% net expense ratio, below the 1.4% peer average, along with our holdings analysis helps support the five star ranking from CFRA.
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Another strong performer is BlackRock Science & Technology Opportunity Portfolio (BGSAX), which rose 25% year to date.. Despite its name, BDSAX has no exposure to health care stocks, but similar to FSPTX has been aided in 2017 due to its inclusion of consumer discretionary stocks, such as Amazon.com (AMZN) and international tech stocks, including Alibaba Group (BABA) and Tencent Holdings.
The above ETFs track a U.S.-focused index and as such the asset managers do not have the flexibility to include Internet retailers or Asian technology companies. While these investments have been rewarding in 2017, they might not always be. Indeed, the average science and technology mutual fund lagged VGT and XLK in 2015 and 2016. A good reminder that past performance is not necessarily indicative of future results.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.