UK investors are pretty poorly served when it comes to sector ETFs.
A long time ago, before investing websites, blogs, and, in particular, e-versions of the daily papers, I used to write abstracts of press articles for a text database subscription service. The work was shared out to the 'abstracters' partly by industry sectors.
I used to have white goods and, possibly by some kind of association, the paper industry and the newspaper industry. After a while I graduated to the oil industry and meetings of OPEC, which I could have made into a Mastermind specialised subject, for a time.
Lack of choice
Maybe this is why, the range of sector investment options for European investors seems sparse to me. The choice of sector investment trusts is quite good but when it comes to other investment funds there's very little to choose from.
In the ETF arena there definitely seems to be room to grow the range of industry sector funds. The most logical offering for UK investors is from db X-trackers with their DJ STOXX 600 range of sector trackers, which boasts attractive annual charges of 0.3%. The DJ STOXX 600 index includes, would you believe, 600 of the largest European companies. It covers 18 countries in all, but nearly 30% of its constituents come from the UK.
These sector ETFs can still be quite concentrated though. For example, DJ STOXX 600 Technology (LSE: XS8R) covers just 25 companies with nearly 60% of your money in just three companies -- Nokia, SAP and Ericsson.
Although iShares has a full range of European industry sector ETFs listed on the Deutsche Boerse and a range of global ones listed in New York, for UK investors there's only a few funds such as iShares S&P Global Water (DH20), which includes water utilities and water equipment manufacturers or iShares S&P Emerging Market Infrastructure (LSE: DEIN).
iShares classifies these themed funds 'alternative' but they can be seen as cousins of sector ETFs. They don't lend them to entirely consistent portfolio building without careful research to see what they comprise. Also, themes can be subject to investment fashions.
When sectors make sense
For dedicated index tracking investors, the first good reason for considering industrial sector ETFs is the overweighting or underweighting of certain sectors in the main indices.
Financials currently account for 23% of the FTSE 100 and slightly more of the DJ STOXX 600. By contrast a mere 0.7% of the FTSE 100 is accounted for by technology stocks. If you believe that one or two industry sectors are running out of control in an index that you're tracking, investments in sector ETFs in industries that are currently unfashionable may be one answer.
Sector ETFs may be a good solution for individual stock pickers who find themselves too concentrated in the sectors they understand and feel at home with. In my own case, working experience has made me more confident investing in oil majors than, say, pharmaceutical stocks.
An investment in db X-tracker's DJ STOXX 600 Health Care (LSE: XSDR) could balance a portfolio that would otherwise be overweight in other, more familiar sectors. Sector ETF investments can be made rapidly and, in particular, without the investor having to learn how to identify the best stocks in the sector.
Beware of overlaps
Industry sector ETFs can often overlap with other investments you may already have.
It's not difficult to see that returns on an oil and gas sector ETF might have correlation with oil or gas ETCs but you might not realise that db X-trackers DJ STOXX 600 Basic Resources ETF (LSE: XSPR) is mainly comprised of London-listed companies such as BHP Billiton (LSE: BLT), Rio Tinto (LSE: RIO) and Anglo American (LSE: AAL), so an investor with a FTSE 100 tracker could easily be doubling their exposure to these companies.
Some investors bracket investing in sectors with taking a view on what stage of the economic cycle has been reached -- going into recession they buy food and tobacco stocks and utilities, when things improve, they aim for manufacturers, house builders or consumer discretionary stocks.
There are two drawbacks to this approach; firstly, the sector ETFs on offer don't give you that level of granularity, secondly, the economic cycle doesn't seem predictable enough to time these investments correctly.
Given that the choice of sector ETFs is so meagre for UK investors, it seems wise to keep suitable specialist investment funds and investment trusts in the frame alongside the ETF range at least until there are more sector ETFs available.
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