Beat the Market With These 9 Sector ETFs

It’s pretty easy to understand the appeal of indexing, particularly after a year like 2014. Less than one out of five active mutual fund managers beat their respective benchmark last year. And those few that did beat their benchmarks did so by a pitiful margin of just 1.8% on average.

spdr-state-street-185Even worse, many fund managers are really just closet indexers. There is too much career risk in going against the grain, so most large fund managers tend to buy the same stocks and sink or swim together. So … why pay steep fees to active managers for underperformwhen you can buy an index mutual fund or ETF with expense ratios of 0.1% or even lower in some cases?

But indexing doesn’t have to mean dumping your nest egg into an S&P 500 ETF like the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) and taking whatever the market gives you. Performance can vary wildly by sector, and if you can add value by allocating to individual sector funds, it makes all the sense in the world to try. For example, just by virtue of being out of the worst-performing sectors — energy in 2014 and utilities year-to-date in 2015 — you could have beaten the S&P 500 by a few percentage points.

Let’s do a deep dive of each of the nine Select Sector SPDR ETFs. We’ll go over what each has to offer … and what it doesn’t.

Technology Select Sector SPDR (XLK)

I’ll start with the Technology Select Sector SPDR (NYSEARCA:XLK), as technology is the biggest component of the S&P 500 by a pretty wide margin. Tech stocks make up more than 18% of the S&P 500.

Unfortunately — and surprisingly, given the perception of technology as a growth sector — the Technology Select Sector SPDR has the second-worst performance of all nine sectors since the inception of the Select Sector ETFs in 1998. Only the financial sector ETF had worse performance — and just barely.

Over the past 16 years, XLK has managed to generate annual returns of just 3.3%. This is a true testament to how overvalued the tech sector was in the late 1990s, though a contrarian might consider this a bullish sign for returns going forward.

When you buy XLK, you’re getting access to the familiar names in consumer electronics, computing and business services. Apple Inc. (NASDAQ:AAPL) is the biggest holding, at 18% of the portfolio, which is befitting a company with a market cap of $740 billion. But Microsoft Corporation (NASDAQ:MSFT), Facebook Inc (NASDAQ:FB) and Google Inc (NASDAQ:GOOG, NASDAQ:GOOGL) also feature prominently in the top 10 holdings. If you want Big Tech, you’re getting it in XLK.

But what you’re not getting is exposure to exciting new technology. Outside of Facebook, social media is not hardly represented at all, and some of the biggest holdings are slow-growing “old tech” companies like Verizon Communications Inc. (NYSE:VZ), International Business Machines Corp. (NYSE:IBM) and Cisco Systems, Inc. (NASDAQ:CSCO).

XLK charges 0.15%, or $15 annually for every $10,000 invested, in expenses. The same can be said about the rest of these Select Sector SPDR ETFs.

Energy Select Sector SPDR (XLE)

Next up is the proverbial red-headed stepchild of the past year, the Energy Select Sector SPDR (NYSEARCA:XLE). As the price of crude oil has collapsed in the past year, so have the share prices of most energy stocks. The Energy Select Sector SPDR is the only sector ETF of the nine to be in negative territory over the past 12 months, down about 8%. It’s also the worst performing sector of the past five years, with annual returns of less than 4%.

Interestingly — and indicative of how cheap and unloved energy stocks were during the 1990s tech boom — the Energy Select SPDR ETF is the best-performing sector since the inception of the Select Sector ETFs in 1998, with returns just shy of 10% per year.

When you buy XLE, you get the oil majors. Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) make up 16% and 13% of the portfolio, respectively. But you also get quality oil-field servicers like Schlumberger Limited (NYSE:SLB) and Halliburton (NYSE:HAL), which make up 7.2% and 2.8% of the portfolio, respectively, and pipeline operators like Kinder Morgan Inc (NYSE:KMI) and Williams Companies Inc (NYSE:WMB), which make up another 4.4% and 3% of the portfolio, respectively.

What you don’t get, unfortunately, are the high dividend yields you might expect from an ETF dominated by payout champs like Exxon Mobil, Chevron, Kinder Morgan and Williams. XLE sports a dividend yield of just 2.4%. This is due to the prevalence of low-yielding exploration and servicing companies that dominate the sector once you get past the top 10 holdings.

Consumer Discretionary Select Sector SPDR (XLY)

The Consumer Discretionary Select Sector SPDR ETF (NYSEARCA:XLY) has been a real standout performer among the Select Sector ETFs, and one of the most consistent. It’s leading the pack year to date with returns of about 5.3%, and its returns over the past three, five and 10 years, as well as since inception, place it near the top over each time period.

The strong performance is all the more remarkable given that it has covered a period of time that saw two deep recessions, two major wars and the highest unemployment rates since the Great Depression. There was simply no stopping American consumers from swiping their credit cards.

When you buy XLY, you’re getting some of the major corporate names you might expect, including theme-park operator and TV and movie studio Walt Disney Co (NYSE:DIS), which is the largest holding at 7% of the portfolio. You also get some of the larger retail chains like Home Depot Inc (NYSE:HD), Lowe’s Companies, Inc. (NYSE:LOW) and Target Corporation (NYSE:TGT) and more frivolous places to drop a few quick bucks like Starbucks Corporation (NASDAQ:SBUX) and Chipotle Mexican Grill, Inc. (NYSE:CMG).

But you also get some less intuitive fit. There are consumer staples-esque stocks, such as discount chain Dollar Tree (NASDAQ:DLTR). You’ll also find automakers General Motors (NYSE:GM) and Ford (NYSE:F), media giants Comcast (NASDAQ:CMCSA) and Time Warner (NYSE:TWX), and (NASDAQ:AMZN), a company that is as much a tech stock as it is a retailer.

Stocks that you might think of as true “discretionaries,” like high-end jewelry and fashion, don’t make up a significant part of the portfolio at all.

XLY is full of high-quality names you come across in your daily life, most of which can fairly be considered “consumer discretionary.” But given the mismatched collection of companies that fill out the ETF, it is by no means a pure play.

Consumer Staples Select Sector SPDR (XLP)

Next up is the Consumer Staples Select Sector SPDR (NYSEARCA:XLP), XLY’s ugly stepsister.

I’m joking, of course. The staples ETF is more conservative than the discretionaries ETF and most of its holdings less flashy, but it is full of names we all know and love. Procter & Gamble Co (NYSE:PG) — the ultimate seller of disposable sundries — is the largest holding at 12.5% of the portfolio. The Coca-Cola Co (NYSE:KO), Wal-Mart Stores, Inc. (NYSE:WMT), Philip Morris International (NYSE:PM) and CVS Health Corp (NYSE:CVS) also make up a good slice of the portfolio.

There are a few head scratchers here. I’m not sure why Target and Dollar Tree are “discretionaries” while Walmart is a “staple.” I also find it odd that a luxury grocer like Whole Foods Market, Inc. (NASDAQ:WFM) or a whiskey maker like Brown-Forman Corporation (NYSE:BF.B) are considered staples. (I mean, I suppose you could argue Jack Daniel’s and organic pomegranate farmed by the hard-working indigenous famers of Kerplackistan are essential to life.) But for the most part, the holdings of XLP make sense.

Yet despite XLP’s conservative portfolio — and despite the fact that its loaded with some of the highest-yielding stocks on the market, such as tobacco stocks — XLP yields only a modest 2.4% in dividends. If you’re looking for yield, you’re better off poaching some of XLP’s higher-yielding holdings than holding the ETF outright.

Financial Select Sector SPDR (XLF)

The worst-performing sector ETF of the past 10 years and since the 1998 inception of the Select Sector SPDRs is, of course, the Financial Select Sector SPDR (NYSEARCA:XLF). Over the past 10 years, it returned 0.14% per year. Since inception, it managed to eke out 2.6% per year.

Given that the worst financial crisis since 1907 centered around this sector, it’s remarkable that its returns are positive at all!

Interestingly — and indicative of how fall the global banking giants have fallen — the largest holding in this ETF isn’t a bank at all. It’s Warren Buffett’s conglomerate Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B), which is considered an insurance company by Standard & Poor’s. Berkshire Hathaway makes up just shy of 9% of the portfolio.

Following quickly behind is one of Berkshire Hathaway’s largest long-term holdings, Wells Fargo & Co (NYSE:WFC). And of course, following Wells Fargo are some of its less prudent competitors, JP Morgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C). Most of the rest of the portfolio is made up of smaller banks, asset managers and brokerage houses.

For the time being, XLF also has a decent-sized exposure to REITs, at about 12% of the portfolio. This is absurd, as there is no practical reason why a shopping mall landlord like Simon Property Group Inc (NYSE:SPG) should ever be in the same sector ETF as Goldman Sachs Group Inc (NYSE:GS).

Luckily, this anomaly won’t be around for much longer. Standard & Poor’s is giving REITs their own standalone sector, and presumably the State Street Select Sector SPDR ETFs will follow suit. (The SPDR ETFs do deviate from time to time. For example, telecom and technology, which S&P breaks into two sectors, share a single SPDR ETF.)

Health Care Select Sector SPDR (XLV)

Next up is the Health Care Select Sector SPDR (NYSEARCA:XLV). The Health Care ETF has been one of the very best performers, generating annualized 28.1% returns over the past three years and 8.5% annualized returns since the inception of the SPDR series in 1998. 28.1% annualized returns are the stuff of 1990s dot-com memory, yet came from one of the S&P 500’s more conservative sectors.

Call it the Obamacare trade.

What you get with XLV is a who’s who list of big pharmaceutical companies like Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE) and Merck & Co., Inc. (NYSE:MRK). You also get exposure to the bigger and more established biotech names, like Gilead Sciences, Inc. (NASDAQ:GILD) and Amgen, Inc. (NASDAQ:AMGN), and to health insurance companies.

What you are distinctly not getting is a good dividend payer. The days when the health sector was considered a high-yield sector are over. XLV is one of the lowest-yielding sector funds with a dividend yield of just 1.3%.

Industrials Select Sector SPDR (XLI)

Next we get to the Industrials Select Sector SPDR (NYSEARCA:XLI). Despite being considered a cyclical sector, the industrials have managed to put up consistent and respectable returns over the life of the SPDR series. Over the past three-, five- and 10-year periods, XLI generated returns of 18%, 17.1% and 7.8%, respectively.

The holdings here are going to include household names like General Electric Company (NYSE:GE) — a company that is thankfully getting back to its industrial roots and leaving its experimentation as a bank in the past.

3M Co (NYSE:MMM), Boeing Co (NYSE:BA) and Lockheed Martin Corporation (NYSE:LMT) also make the top 10, as you might expect. But XLI also has quite a few stocks that you might not think of as “industrials,” per se, including airlines like Delta Air Lines, Inc. (NYSE:DAL) and parcel companies like United Parcel Service, Inc. (NYSE:UPS).

And somewhat bizarrely, white-collar headhunting firm Robert Half International (NYSE:RHI) makes the list as well.

Don’t expect much in the way of dividends with this ETF. At 1.8%, its yield is about in line with the broader S&P 500.

Materials Select Sector SPDR (XLB)

Next on the list is the Materials Select Sector SPDR ETF (NYSEARCA:XLB). XLB’s performance over its life has been quite good, roughly doubling the return of the S&P 500 since inception in 1998.

This sector ETF is not at all what it sounds like. When you hear “materials,” you expect a portfolio full of mining companies. But the materials sector ETF is more diverse than that. Chemical companies E I Du Pont De Nemours And Co (NYSE:DD) — which most know better as DuPont — and Dow Chemical Co (NYSE:DOW) are the first and third largest holdings, at 11.5% and 8.9% of the portfolio, respectively. Agribusiness giant Monsanto Company (NYSE:MON) fills in the gap at No. 2, with 9.5% of the portfolio.

Paper products company International Paper Co (NYSE:IP) and paint seller Sherwin-Williams Co (NYSE:SHW) also make the top ten holdings. The largest mining company in the portfolio — Freeport-McMoRan Inc (NYSE:FCX) — makes up only 3% of the portfolio.

In XLB, you get a solid portfolio of global industrial companies. You distinctly do not get a collection of volatile mines at risk of copper price swings.

Utilities Select Sector SPDR (XLU)

And finally, we get to the Utilities Select Sector SPDR ETF (NYSEARCA:XLU). The utilities sector was one of the real standouts of the last year, up about 16%. And for calendar year 2014, the utilities sector was the strongest performer of all sectors, due in no small part to the massive decline in bond yields.

As the most “bond-like” of all sectors, utilities tend to move with bond yields. This was a disaster in 2013, the year of the “taper tantrum.” And it’s shaping up to be a disaster this year, as the utilities sector is the only S&P 500 sector currently in the red year-to-date. XLU is down more than 6% since the start of the year.

If you’re looking for a portfolio of boring, regulated basic utility companies like Duke Energy Corp (NYSE:DUK) or Dominion Resources, Inc. (NYSE:D), then XLU is the ETF for you.

But if you’re specifically hunting for high yield, you might want to keep looking. After the run XLU had, its dividend yield has fallen all the way to just 3.3%.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, he was long AAPL, IP, KMI, MSFT, WMB and WMT.

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