Sector Benchmark ETFs

“You cannot invest in an index” is the standard disclosure that accompanies any index returns when used as a performance benchmark. Therefore, I try to avoid the use of indexes whenever possible. To me, it makes much more sense to look at vehicles that you can invest in—such as index-based exchange-traded funds (“ETFs”). This makes ETFs such as the SPDR S&P 500 (SPY), iShares Russell 2000 (IWM), PowerShares QQQ (QQQ), and iShares MSCI EAFE (EFA) better performance representatives than their underlying indexes.

When analyzing U.S. sector performance, ETFs are once again the better choice. Contrary to many analysts, I do not base my sector analysis on the Select Sector SPDRs. To me, this family has two major shortcomings. First, the suite does not correctly represent all 11 sectors of the Global Industry Classification Standard (“GICS”). Instead, it tucks the stocks belonging to the Telecommunications sector inside the Technology ETF. Secondly, these ETFs limit their holdings to just the stocks within the S&P 500 Index, depriving investors of exposure to small- and mid-cap stocks.

In my opinion, the Vanguard suite of sector ETFs provide better benchmarks. They follow the GICS classification system and encompass more than 2,500 stocks, representing about 97% of the entire U.S. market capitalization. These 11 ETFs have combined assets of $100 billion, with the smallest one holding $1.4 billion. Additionally, they are all very liquid (highly tradeable) and carry an expense ratio of just 0.10% (except where noted). Vanguard introduced most of these ETFs in 2004 as alternative share classes to its sector mutual funds, which have an even longer history.

Listed in order of their percentage allocations of the U.S. market capitalization, the Vanguard suite of sector ETFs consist of the following:

Vanguard Information Technology (VGT): Representing about 20.0% of the U.S. market, this ETF currently holds 373 stocks and has a yield of 1.3%. Top industry allocations include Internet Software & Services 19.8%; Hardware, Storage, and Peripherals 15.3%; Systems Software 14.2%; Semiconductors 13.8%; Data Processing & Outsourced Services 11.4%; IT Consulting 6.6%; Application Software 6.0%; and Communication Equipment 5.6%.

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Disclosure: Author has no positions in any of the securities, companies, or ...

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