Advisors are Leaning Into Sectors - But Which Ones? | ETF Trends

With sector ETFs pulling in over $40 billion in new assets so far in 2020, more and more investors and advisors are using Sector ETFs to express their opinions on winners and losers in the global economic recovery. But that’s not the only use for the funds, which date back to some of the earliest ETFs.

“There are two applications,” Dan Dolan, Director of Wealth Management Strategies, Sector SPDRs, told ETF Trends. “One is in stock substitute – so, you’re looking at people that traditionally bought individual stocks. Diversification in the risk process of minimizing single stock exposure…” This core use of sectors is certainly at work today, as investors have grown weary of the shocking volatility in the largest momentum names in technology and health care in particular.

“But,” continued Dolan, “the second use case is really the more interesting — fee-based financial advisors building model portfolios based on sector allocations, and customizing those allocations to meet a particular objective, whether that is income, growth or something in between.”

The most widely used sector ETFs are the original Select Sector SPDRs, which break the S&P 500 into broadly recognized groupings based on their primary business activities:

Incorporating sector-based investment strategies can help investors align and adjust their investment portfolios based on macroeconomic or thematic trends, such as the increased adoption of clean energy and declining interest rates, shifts in stock fundamentals, or technical indicators, such as momentum. The S&P 500 was difficult to beat in the ten years following the financial crisis. However, in 2020, it’s a different story as some sectors, notably Information Technology, Communication, and Healthcare, are performing well, while Energy, Financials, and Industrials are challenged. And the flows have followed:

Source: Bloomberg, as of 9/15/20

“Sectors are more important than any style box,” Dolan added.

Investors have been utilizing State Street Global Advisors’ suite of Select Sector SPDR ETFs to gain targeted market exposure through the year. Select Sector SPDR ETF assets under management were at $145 billion in January, dipped to $100 billion in March, and bounced back to as high as $165 billion.  But the assets in the series don’t mimic the weights of the S&P 500.  Utilities, for example, make up a scant 2.8% of the S&P 500, but XLU, the Select Sector SPDR targeting the sector, represents over 7% of the assets in the series.  Conversely, the recently formed Communication Services sector is over 11% of the S&P 500, under 7% of the assets in Select Sector SPDRs.

The moral of the story? Sector ETFs let you reweight the markets to reflect your insights.

For more ETF-related commentary from Tom Lydon and other industry experts, visit our video category.