Analysis and Opinion »

S&P 500 Sector ETFs: A Look Under the Hood, Part 1

Charles Sizemore
Share on StockTwits
Published on

It’s pretty easy to understand the appeal of indexing, particularly after a year like 2014. Less than one out of five active mutual fund managers beat their respective benchmark last year. And those few that did beat their benchmarks did so by a pitiful margin of just 1.8% on average.

Even worse, many fund managers are really just closet indexers. There is too much career risk in going against the grain, so most large fund managers tend to buy the same stocks and sink or swim together. So … why pay steep fees to active managers for underperformwhen you can buy an index mutual fund or ETF with expense ratios of 0.1% or even lower in some cases?

But indexing doesn’t have to mean dumping your nest egg into an S&P 500 ETF like the SPDR S&P 500 ETF Trust (SPY) and taking whatever the market gives you. Performance can vary wildly by sector, and if you can add value by allocating to individual sector funds, it makes all the sense in the world to try. For example, just by virtue of being out of the worst-performing sectors — energy in 2014 and utilities year-to-date in 2015 — you could have beaten the S&P 500 by a few percentage points.

Let’s do a deep dive of each of the nine Select Sector SPDR ETFs. We’ll go over what each has to offer … and what it doesn’t.

Technology Select Sector SPDR (XLK)

I’ll start with the Technology Select Sector SPDR (XLK), as technology is the biggest component of the S&P 500 by a pretty wide margin. Tech stocks make up more than 18% of the S&P 500.

Unfortunately — and surprisingly, given the perception of technology as a growth sector — the Technology Select Sector SPDR has the second-worst performance of all nine sectors since the inception of the Select Sector ETFs in 1998. Only the financial sector ETF had worse performance — and just barely.

Over the past 16 years, XLK has managed to generate annual returns of just 3.3%. This is a true testament to how overvalued the tech sector was in the late 1990s, though a contrarian might consider this a bullish sign for returns going forward.

When you buy XLK, you’re getting access to the familiar names in consumer electronics, computing and business services. Apple Inc. (AAPL) is the biggest holding, at 18% of the portfolio, which is befitting a company with a market cap of $740 billion. But Microsoft Corporation (MSFT), Facebook Inc (FB) and Google Inc (GOOG) (GOOGL) also feature prominently in the top 10 holdings. If you want Big Tech, you’re getting it in XLK.

But what you’re not getting is exposure to exciting new technology. Outside of Facebook, social media is not hardly represented at all, and some of the biggest holdings are slow-growing “old tech” companies like Verizon Communications Inc. (VZ), International Business Machines Corp. (IBM) and Cisco Systems, Inc. (CSCO).

XLK charges 0.15%, or $15 annually for every $10,000 invested, in expenses. The same can be said about the rest of these Select Sector SPDR ETFs.

Energy Select Sector SPDR (XLE)

Next up is the proverbial red-headed stepchild of the past year, the Energy Select Sector SPDR (XLE). As the price of crude oil has collapsed in the past year, so have the share prices of most energy stocks. The Energy Select Sector SPDR is the only sector ETF of the nine to be in negative territory over the past 12 months, down about 8%. It’s also the worst performing sector of the past five years, with annual returns of less than 4%.

Interestingly — and indicative of how cheap and unloved energy stocks were during the 1990s tech boom — the Energy Select SPDR ETF is the best-performing sector since the inception of the Select Sector ETFs in 1998, with returns just shy of 10% per year.

When you buy XLE, you get the oil majors. Exxon Mobil Corporation (XOM) and Chevron Corporation (CVX) make up 16% and 13% of the portfolio, respectively. But you also get quality oil-field servicers like Schlumberger Limited (SLB) and Halliburton (HAL), which make up 7.2% and 2.8% of the portfolio, respectively, and pipeline operators like Kinder Morgan Inc (KMI) and Williams Companies Inc (WMB), which make up another 4.4% and 3% of the portfolio, respectively.

What you don’t get, unfortunately, are the high dividend yields you might expect from an ETF dominated by payout champs like Exxon Mobil, Chevron, Kinder Morgan and Williams. XLE sports a dividend yield of just 2.4%. This is due to the prevalence of low-yielding exploration and servicing companies that dominate the sector once you get past the top 10 holdings.

Continue to Part 2:  S&P 500 Sector ETFs: A Look Under the Hood, Part 2

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

This article first appeared on Sizemore Insights as S&P 500 Sector ETFs: A Look Under the Hood, Part 1

Share on StockTwits