Investing in Sector ETFs
(Sector-Based Exchange Traded Funds)

Sector ETFS are exchange traded funds that have stocks (or another instrument) from a single market sector as their underlying investment. Investing in these instruments provides “concentrated diversification”, reducing risk when compared to buying individual stocks. Even so, they are typically more volatile than ETFs that that include multiple market sectors as part of their investment strategy. Today, over one-third of all exchange traded funds are sector-based. Some of the typical sectors include technology, energy, financials, healthcare and utilities.

Concentrated Diversification

Investors often look to sector ETFs when they have singled out a particular sector that they believe will outperform the overall market. This focused strategy offers a way to participate in sector growth while avoiding the risk associated with individual stock picking. This approach can help protect you from the possibility of picking the wrong stock in the right industry.

The Downside

Investing in sector ETFs does have its downside as expenses tend to be higher that those of more broad-based funds. In general, the narrower the concentration the higher the expenses. There are also those who feel that sector ETF investing does not offer the diversification most investors should be looking for as stocks in the same industry often move in the same direction. They would also argue that this concentration may not be much less risky than individual stock picking as some funds concentrate too heavily on too few stocks.

A Sector Rotation Strategy

Sector rotation is an ETF investment strategy under which the investor moves into and out of various sector funds in concert with market cycles. Investors using this approach must identify the sectors for the rotation and their associated business cycles. The goal is to buy into these sectors during their down periods and sell when the prices are at their highest.

Many experts say these instruments are not always used wisely, believing that investors have gotten too speculative with sector EFTs, too often ignoring the underlying securities and fundamentals.

More about Sector ETFs

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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