McCall’s Call: Tech ETFs Deserve Closer Look

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Technology rarely comes to mind when you're looking for value in the stock market. That said, this year, that happens to be the case-an interesting twist considering how much the recession has created pent-up spending on everything from new computers to cutting-edge software.

Matthew D. McCall With the exception of the six months between the Lehman Brothers collapse and the March 2009 bottom, technology stocks are trading at their lowest valuation levels since 1992. Bloomberg data show tech firms included in the S&P 500 trading with a price-to-earnings ratio of 15.6 based on reported annual income.

In other words, because the entire sector is trading at such attractive valuations, it's a perfect situation to own a technology ETF, which enables you to avoid taking the company-specific risk of owning an individual stock by owning a security that encompasses the entire sector.

There's one catch. With over 25 technology ETFs available, the selection process is integral in meeting the needs of your portfolio.

Technology ETF Choices

The largest technology ETF based on assets is the Technology Select Sector SPDR ETF (NYSEArca:XLK), which fell 4.4 percent this year through July, lagging the S&P 500's return of -1.2 percent.

XLK is very heavily weighted toward the large-cap technology names such as Apple (NasdaqGS:AAPL), Microsoft (NasdaqGS:MSFT) and IBM ( IBM ). The top three names make up 27 percent of the entire ETF. This lack of stock diversification is mitigated by the fact that the fund doesn't have more than 20 percent in one industry. The expense ratio is a low 0.21 percent, and the ETF is composed of a total of 83 stocks.

The iShares Dow Jones US Technology ETF (NYSEArca:IYW) is nearly a mirror image of XLK, with identical top holdings. The two major differences are the expense ratio that is more than double, at 0.48 percent, and the number of holdings (162).

The Vanguard Information Technology ETF (NYSEArca:VGT) is the last of the "three amigos" and also shares the top holdings, with an expense ratio of 0.25 percent.

With XLK and VGT similar in holdings and fees, it comes down to volume for me, and XLK is the more liquid of the two ETFs.

Going International

I also want to point out two ETFs that focus on companies outside the U.S-one exclusively and one a lot less so.

First, there's the SPDR S&P International Technology Sector ETF (NYSEArca:IPK), which has zero exposure to the U.S. and more than 50 percent in Asia. Japan makes up the majority with 42 percent, followed by South Korea at 16 percent. The ETF holds a total of 106 stocks, with Samsung the largest holding by far at 14 percent. I mention that because the large allocation to a single stock can be a concern.

The iShares S&P Global Technology Sector ETF (NYSEArca:IXN) calls itself global, but with 74 percent of its assets in the U.S. and the same top three holdings as its U.S. counterpart ( IYM ), the name is a misnomer. Of the top 10 holdings, only two are based outside the U.S. and, not including Japan, the ETF's international exposure is a mere 16 percent.

Investors looking to gain true international exposure have to tilt toward IPK over IXN because IXN will simply give you overlap to the U.S.-based technology ETFs.

Niche Technology ETFs

Within the technology sector there are individual industries that are covered by niche ETFs.

One of the most popular is the Semiconductors HOLDRS ETF (NYSEArca:SMH), composed of 18 stocks in the chip industry. Due to the small number of stocks in the ETF, the top three make up over half of the allocation. As such, SMH is not considered diversified and is heavily dependent on the move of a small number of stocks.

One of my favorite technology ETFs is the iShares S&P Software ETF (NYSEArca:IGV). It invests in 51 software-related ETFs. The largest holding is only 9 percent of the allocation and there's true diversification throughout one of the best-positioned industries in the market.

Why Technology?

As companies look to spend the record amount of cash on their balance sheets, expect to see spending on technology, particularly in software upgrades, as automation takes the place of human labor. This transition won't be good for the unemployment rate, but it does help improve the bottom line of the companies.

Overall spending by companies in all sectors of the market has been stagnant for a few years due to the recession. As the economy continues to improve, the spending will increase and technology companies from software to hardware will be the big winners.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.

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Copyright ® 2010 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs

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