When investing in equity ETFs, there are many choices beyond broad based funds. Sector ETFs are one popular option for investors. These ETFs concentrate their holdings within specific sectors of the economy like Finance or Health Care. Accordingly sector ETFs carry increased risk and reward relative to broad based ETFs like track benchmarks like the S&P 500.
The first half of 2014 has produced performance numbers that illustrate this dynamic. The broad based SPDR S&P 500 ETF (SPY) has delivered a return of 6.05% year to date as of June 30, 2014. This compares to a range of sector ETF returns from a loss of .13% in the Consumer Discretionary Select Sector SPDR ETF (XLY) to a gain of 16.75% produced by the Utilities Select Sector SPDR ETF (XLU). Here’s the chart comparing the year to date performance of the nine Select Sector SPDR ETFs to the S&P 500 Index via the Select Sector SPDR ETF website.
Five of nine Select Sector SPDR ETFs have outperformed the S&P 500 in 2014. While the outperformance by the aforementioned XLU and the Energy Select Sector SPDR ETF (XLE) is substantial, these sector ETFs have been distanced by several industry ETFs this year.
Industry ETFs carry even more risk and reward potential than sectors. These ETFs are narrowly focused within sectors. Examples include the biotech industry within Healthcare or the solar industry within the Energy sector. Industry ETFs are only for aggressive equity investors as volatile price movements can make sector ETFs look tame. Here are six industry ETFs outperforming their sectors in the first half of 2014.
Four leading industry ETFs in the chart above come from the Materials sector, specifically the mining industry. Gold mining and silver mining ETFs have rebounded sharply in 2014 after a horrid 2013. The Markets Vectors Gold Miners ETF (GDX) and the Market Vectors Junior Gold Miners ETF (GDXJ) have returned 20% and 29% respectively. The Global X Silver Miners ETF (SIL) has appreciated 22% while the Pure Funds Junior Silver Miners ETF (SILJ) has led the mining peer group with returns of over 36%. With all this solid performance, why has the Materials Select Sector SPDR ETF (XLB) returned just 7.4% year to date? The answer is that just 14.9% of XLB was invested in the “metals and mining” industry according the fund’s most recent fact card.
Health Care Champions
Two other leading sub sector ETFs come from the Healthcare sector but are focused in the biotech and pharmaceutical industry. The SPDR S&P Biotech ETF (XBI) and the SPDR S&P Pharmaceutical ETF (XPH) have returned 18% and 19% respectively. These returns have almost doubled the Healthcare Select Sector SPDR ETF (XLV) this year. According to the most recent XLV fund fact card, XLV had a 46% allocation to pharmaceutical companies and a 17.9% biotech weighting. This left more than a third of XLV allocated to other industries that didn’t fare as well.
To be fair, we should take a look at a longer-term period when it comes to the industry ETFs highlighted above. As mentioned before, industry ETFs can exhibit significant upward and downward volatility. In 2013 both scenarios played out. The winning mining subsector ETFs of today were massive losers but the biotech and pharmaceutical ETFs surged. Here’s the 2013 performance chart showing each of the subsector ETFs we’ve reviewed thus far.
Many investors could not stomach a fund losing more than 50% of its value in a year but that’s exactly what occurred in the four mining ETFs in 2013. Substantial share price volatility – upward and downward - from industry funds is a real possibility that investors should be prepared to face. For example one wonders how many mining ETF shareholders in 2013 stayed long enough to experience the strong start to 2014.
Weigh Risk & Reward
Industry ETFs will continue to offer investors increased risk and reward potential. While 2014 has produced strong returns in several industry ETFs investors should carefully weigh the risks and rewards of pursuing these more volatile funds. While some investors will still seek industry and perhaps sector ETF opportunities, many are better suited to stay invested in broad based ETFs that historically offer a smoother investment experience.