Technology ETF Homework Pays Off

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By Christian Magoon
CEO, Magoon Capital

It pays to do your homework before investing in a technology ETF. Why? Sixteen technology sector ETFs exist in the marketplace today according to data from Index Universe (more if you include ETNs). While several technology ETFs overlap, there are significant differences within the peer group. For example expense ratios run from a low of 18bps to a high of 70bps. In addition to expense ratio differences, some technology ETFs take a broad based approach while others focus on technology sub-sectors.

The variability of expense ratios and index focal points can lead to massive performance differences. The chart below illustrates a 26% percent point performance difference in 2012 for two technology ETFs - the Technology Select SPDR ETF (XLK) and the SPDR S&P Semiconductor ETF (XSD). Here's the year to date performance chart from the NASDAQ Interactive Chart Center.

Clearly technology ETFs are not homogenous and investors must do their homework before selecting a technology ETF. Let's review this group in closer detail focusing on two categories with a wide range of inputs: expense ratio and performance.

Expense Ratio

While there has been a lot of conversation in the ETF industry about expense ratios lately, it is important to realize that fees are just one point that should be examined. ETF variables like the type of index being tracked often have a greater impact on performance. In fact, the chart above shows that concept in action. Year to date the nature of the index being tracked by each ETF, in this case sector versus sub-sector, has clearly delivered more performance impact than the expense ratio difference of 17bps between the funds.

With that being said, the technology ETF peer group has a wide range of expense ratios. Here are two examples the define the fee boundaries of this group.

  • Lowest Expense Ratio: Technology Select SPDR (XLK) @ 18bps
  • Highest Expense Ratio: First Trust AlphaDex Technology ETF (FXL) @ 70bps

The First Trust AlphaDex Technology ETF is about 3.9 times more expensive than the Technology Select SPDR ETF. While this data point does not make either ETF a good or bad choice, it does give the SPDR ETF a distinct advantage when it comes to subtracting fees from the gross performance of the ETF. Here's the entire list of technology ETFs and ETNs and their expense ratios from the Index Universe Data Tool.

Performance

It has been said that the cost of something only becomes an issue in the absence of value. Based on that concept, assessing investments by their performance after fees seems logical. This net number provides an apples to apples comparison of what really matters to investors in the end - the performance of the investment within their portfolio. Here's another Index Universe chart displaying technology ETFs and ETNs ranked by 2012 performance.

Note that XLK is the best performer in 2012 and 2011. It also was only one of two technology ETFs to achieve gains in 2011. 2012's third place ETF, the Vanguard Information Technology ETF (VGT), was the other positive technology ETF in 2011. Both of these ETFs also happen to be the least costly ETFs in the peer group. Finally the top 4 technology ETFs (all gaining at least 19%) are primarily broad based in nature. They don't focus on sub-sectors like semiconductors or networking for example. This broad based approach has been rewarded in 2012 and 2011, as have the lowest cost funds implementing this approach.

Investors should examine the technology ETF peer group carefully before investing. Like many categories of ETFs, there are significant differences in the category which can result in unique return sets. While the lowest cost technology ETFs have outperformed lately, focusing solely on cost is a mistake. The investment objective, or focus, of the index being tracked will usually impact the ETF's performance more significantly. The bottom line for investors: do your homework on technology ETFs.



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



This article appears in: Investing , ETFs , Investing Ideas , Technology

Referenced Stocks: FXL , VGT , XLK

Christian Magoon

Christian Magoon

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