THE QUALITY MIGRATION CYCLE AND MARKET TOPS
CHAPTER 7 CHAPTER 7
An Investment Revolution:
Exchange-Traded Funds
O
ver the past decade, an investment revolution has taken hold in which investors are now able to invest like investment managers without the cost and supervision of numerous individual positions required of profes- sional investors. Investors can now build portfolios based on:■ Economic sectors
■ Industries
■ Styles
■ Global assets
■ Hard assets
Consider these facts:
■ Whole sectors can be represented with the purchase of one stock—an economic sector exchange-traded fund (ETF).
■ Whole industries can be captured with the purchase of one stock—an industry ETF.
■ Whole styles can be captured with the purchase of one stock—a style- oriented ETF.
■ Whole countries and regions can be represented with the purchase of one stock—a country or regional ETF.
■ Hard assets, like gold, can be captured with the purchase of one stock—a hard asset ETF.
On its own, this would be quite an exhilarating experience. To de- cide, for example, that the Energy sector or Japan or mid-cap stocks
165
look especially attractive and, therefore, to be able to participate in that decision (right or wrong, up or down) is a power that more and more investors are catching onto with each passing day via the purchase of ETFs.
In the past such a decision to invest in a sector would have required ei- ther of the following additional decisions:
■ The selection of the individual stocks within that sector, country, or style.
■ The placement of money with a money manager specializing in that area.
For those investors with a finite amount of money, time, and resources, not having to decide which one or two stocks within each chosen area to own or which money manager may perform well in the future, ETFs are a fantastic alternative to the choices of the past.
Now, for some investors, having the ability to own whole sectors or styles is a very attractive option. Make the decision, make the bet. But I am aiming for something even more significant. I am aiming for the ability to construct portfolios and produce consistent and reliable investment results using ETFs in a portfolio strategy.
ETFs are more than just an alternative to a great insight on an in- vestor’s part. They are a tool that enables the creation of an effective port- folio—an effective portfolio that can produce more consistent results with lower risk than the great-idea-of-the-day investing approach so prevalently advocated by far too many media investment mavens. Great idea investing, like hot tip investing, is just too hit-or-miss to be a reliable longer-term strategy. For most investors, the effective portfolio is a better way to man- age one’s investment assets.
In the sectors and styles approach that I employ, ETFs are the core in- vestment instrument used. They are the substance of my Core Plus strat- egy described in Chapter 3. Moreover, with the ability to own sectors, industries, and so on, an investor can construct a portfolio that is suited to his/her needs. Retirement plans can be more effectively met using the Core Plus strategy and ETFs. Growth needs for the future can be more reliably met using Core Plus and ETFs. This list goes on and on. The bottom line is simply this: With ETFs, every investor with a modest sum of money (de- fined as $25,000) can build a well-diversified portfolio using Core Plus and ETFs and make changes as needed—a true investment revolution for the taking.
TYPES OF ETFs: ECONOMIC SECTORS
The world of ETFs is large and growing. More than 200 ETFs exist to- day and over $300 billion in assets are already invested in ETFs. Take, for example, the Information Technology sector and the primary indus- tries within:
ETF Symbol
Technology Select Sector SPDR XLK
iShares Dow Jones U.S. Technology IYW
iShares Goldman Sachs Technology Index IGM streetTRACKS Morgan Stanley Technology MTK Vanguard Information Technology VIPERs VGT
iShares Goldman Sachs Networking IGN
iShares Goldman Sachs Semiconductor IGW iShares Goldman Sachs Software Index IGV Or the Health Care sector:
ETF Symbol
Health Care Select Sector SPDR XLV
iShares Dow Jones U.S. Healthcare IYH
Vanguard Health Care VIPERs VHT
PowerShares Dynamic Pharmaceuticals PJP
iShares NASDAQ Biotechnology IBB
PowerShares Dynamic Biotech & Genome PBE And in each case, a global ETF on the sector is available.
ETF Symbol
iShares S&P Global Technology Sector IXN iShares S&P Global Healthcare Sector IXJ
This is but a small sample of the types of sector and industry ETFs one can invest in. To help gain a slightly larger sense of the ETF landscape, here is one way to view what’s out there in the world of ETFs.
On a daily basis, I monitor the markets in the manner shown in Table 7.1.
The ETFs, classified by economic sector and selected industry, size and style, global market, and other (hard assets), help me to capture a sense of
the market. This cross-sectionalization of the market provides a quick and deep insight into what areas are performing well and which ones are lag- ging. There are many more ETFs, but these are the ones that I find to be of greatest use as of the third quarter of 2005. In time, especially as more in- dustry-specific ETFs become available, the list will expand.
Constructing your own market tracking system via ETFs is easy and free. Web sites such as Yahoo! Finance enable the construction you see in Table 7.1—nothing fancy, just effective.
TABLE 7.1 Potential ETF Portfolio Mix Economic Sectors and Selected Industries
Consumer Discretionary XLY
Consumer Staples XLP
Energy XLE
Financials XLF
Health Care XLV
Biotech IBB
Industrials XLI
Basic Materials XLB
Information Technology IYW
Semiconductors IGW
Software IGV
Networking IGN
Telecommunications IYZ
Utilities XLU
Size and Styles
Mid Cap MDY
Mid Cap Value IJJ
Large Cap—Dow Industrials DIA
Large Cap—S&P 100 OEF
Small Cap IJR
Micro Cap IWC
Global
EAFE EFA
Europe 350 IEV
Asia Pacific ex Japan EPP
Japan EWJ
Emerging Markets EEM
Other
Gold GLD
Source:iViewResearch.
TYPES OF ETFs: SIZES AND STYLES
Investing based on size (market cap) and style (growth, value) is part of the mix, as evidenced by my market tracker in Table 7.1. Here is a small sam- ple of ETFs based on size and style.
Large Cap Growth
ETF Symbol
iShares S&P 500/BARRA Growth Index IVW iShares Morningstar Large Growth Index JKE streetTRACKS Dow Jones U.S. Large Cap Growth ELG PowerShares Dynamic Large Cap Growth Portfolio PWB
Vanguard Growth VIPERs VUG
iShares Russell 1000 Growth Index IWF
iShares Russell 3000 Growth Index IWZ
NASDAQ 100 Trust Shares QQQQ
Fidelity NASDAQ Composite Index Tracking ONEQ Mid Cap Value
ETF Symbol
iShares Dow Jones Select Dividend Index DVY PowerShares Dynamic Mid Cap Value Portfolio PWP iShares Russell Mid Cap Value Index IWS iShares Morningstar Mid Value Index JKI PowerShares High Yield Dividend Achievers PEY iShares S&P Mid Cap 400/BARRA Value IJJ
Global (country and regional) and hard assets are also available. And for those investors wishing to satisfying their asset allocation needs, fixed- income-related ETFs are available, as well.