Are SPDRs Truly Your Best Sector Bet?

by Daniel Putnam | September 10, 2013 3:29 pm

When most investors think of ways to gain exposure to specific sectors, State Street Global Advisors’ SPDR sector ETFs are probably the first vehicles that come to mind. They’re big, they’re liquid, they’ve been in existence for nearly 15 years, and — in case they slip your mind for a moment — their advertising campaign is ubiquitous.

Still, it might pay to take a closer look at exactly what’s under the hood of these popular ETFs — and whether an equal-weight approach might provide a more accurate representation of sector performance.

Here’s why: Because of their capitalization-weighted approach, the sector SPDRs hold exceptionally large weightings in their top holdings. This means that while the funds may be diversified in the sense that they own several dozen positions, ultimately only a handful of stocks drive performance.

Of the nine funds in the family, the one that is most well-known for its top-heavy composition is the Technology SPDR (XLK[1]). Although XLK isn’t as concentrated as it was last year when Apple (AAPL[2]) was at its peak, the fund still holds 15.3% in the stock. In combination with other large holdings such as Google (GOOG[3]) and Microsoft (MSFT[4]) — each of which checks in with weightings north of 7% — XLK holds 42.9% of assets in its top five stocks, and 62.3% in its top ten.

The Materials SPDR (XLB[5]) has an even larger tilt toward its top holdings thanks to its 10%-plus weightings in Monsanto (MON[6]) and DuPont (DD[7]), with morethan two-thirds of its assets in its top ten holdings.

The issue of concentration isn’t unique to these two funds. In fact, it’s visible across all of the SPDR ETFs:

Sector SPDR Ticker Top 5 Weighting Top 10 Weighting
Materials XLB 43.5% 66.5%
Consumer Staples XLP 45.9% 65.2%
Technology XLK 42.9% 62.3%
Energy XLE 45.3% 60.9%
Utilities XLU 37.2% 57.55
Health Care XLV 39.3% 56.6%
Financials XLF 37.6% 51.2%
Industrials XLI 31.4% 49.0%
Consumer Discretionary XLY 29.4% 45.4%

Using an equal-weighted approach, such as the one employed by Guggenheim Investments in its series of nine equal-weight sector ETFs, eliminates this concentration problem. Rather than tracking the returns of a handful of mega-caps, these funds offer investors more of a “pure play” on broad sector performance.

The table below shows the percentage of each portfolio held in the top 10 stocks. These numbers should remain relatively static over time, since the weighting in the top holdings largely reflects the number of stocks in the fund rather than market cap shifts or the returns of the underlying holdings.

Sector Guggenheim ETF Ticker Top 10 Weighting
Materials RTM 34.9%
Utilities RYU 28.8%
Consumer Staples RHS 27.1%
Energy RYE 26.0%
Health Care RYH 21.0%
Industrials RGI 17.7%
Technology RYT 16.5%
Consumer Discretionary RCD 14.5%
Financials RYF 14.0%

Lower concentration isn’t the only advantage of the equal-weight approach. Since Guggenheim opened these ETFs in late 2006, seven of the nine funds have outperformed their capitalization-weighted SPDR counterpart:

Sector Guggenheim AVG. ANN. Return 11/7/06-9/9/13 SPDR AVG. ANN. Return 11/7/06-9/9/13
Materials 7.5% 5.4%
Industrials 7.3% 6.0%
Energy 7.8% 7.4%
Financials -2.7% -6.2%
Consumer Staples 10.5% 9.3%
Consumer Discretionary 8.3% 8.5%
Health Care 11.1% 7.9%
Technology 5.6% 6.3%
Utilities 5.0% 4.2%

There are two one disadvantages to the equal-weight approach. First is expenses: The Guggenheim ETFs charge 0.5% per annum, versus just 0.18% for the SPDRs. So far, this hasn’t represented a major issue due to the superiority of the equal-weighed strategy versus the capitalization-weighted approach.

Second, since fewer investors are aware of these funds in comparison to the SPDRs, they’re relatively small. The nine Guggenheim funds, on average, have $88.7 in assets under management — well beneath the $7.4 billion average for the SPDR ETFs and under the $200 million level at which the long-term survival of an ETF comes into question. Longer-term investors therefore need to be aware that there is an outside chance these funds may close at some point in the future. This appears unlikely, however, given that the equal-weight approach is beginning to catch on.

Aside from these factors, equal-weighted sector funds are a compelling alternative not just for longer-term investors, but also short-term traders and those seeking “position trades” for several weeks or months.

In the case of sector ETFs, bigger isn’t necessarily better.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

  1. XLK:
  2. AAPL:
  3. GOOG:
  4. MSFT:
  5. XLB:
  6. MON:
  7. DD:

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