The rise of sector ETFs: what can I invest in?
US banks could potentially be set for a strong performance over the next couple of years. This is because banks usually become more profitable as interest rates rise and with President Donald Trump looking to trim financial regulation, US banks may have more freedom to increase their earnings. But what is the best way to benefit from possible rises in the share price of the likes of JP Morgan and Bank of America?
Exchange-traded funds (ETFs) are the perfect instrument to cherry pick individual industries when constructing a sector-based portfolio. In this second instalment of our three-part series on sector ETFs, we explain how these sectors are defined and what you can buy for your portfolio.
Who decides which company fits into each sector?
Each company in the equity market universe is categorised into a particular sector and industry which provides a standardised industry definition for investors. However, there are two methodologies for classifying each stock:
- Global Industry Classification Standard (GICS) by MSCI and Standard & Poor’s
- Industrial Classification Benchmark (ICB) by Dow Jones and FTSE
|1. Energy||1. Oil and Gas|
|2. Materials||2. Basic Materials|
|3. Industrials||3. Industrials|
|4. Consumer Discretionary||4. Consumer Goods|
|5. Consumer Staples||5. Consumer Services|
|6. Healthcare||6. Healthcare|
|7. Financials||7. Financials|
|8. Information Technology||8. Technology|
|9. Telecommunication Services||9. Telecommunications|
|10. Utilities||10. Utilities|
|11. Real Estate||-|
The main difference between the two methods is how the two consumer-centric industries are categorised. The GICS method divides consumer stocks by staples (non-cyclical) and discretionary (cyclical) whereas the ICB method splits them by providers of goods and providers of services.
Another variance between the two standards is how GICS separate real estate from the financial sector. The few real estate ETFs that are available contain both property companies as well as real estate investment trusts (Reits) and so we will focus on this sector in a different article.
In our view, the GICS approach is more appropriate when picking stocks or ETFs for a portfolio based on sector rotation. This is because the differentiation between luxury (discretionary) and essential (staples) products provides a better divide for investors who want to benefit from the performance of different sectors which profit during certain stages of the business cycle.
Under both methods there are three further sub-divisions. Currently however, only the highest levels of the GICS and ICB sectors shown are actually investable through ETFs, bar a few in-trend industries such as Automation and Robotics (search for iShares Automation & Robotics UCITS ETF – RBTX – in our Share Dealing platform).
What is out there that I can buy?
We have filtered through the ETF universe for sector ETFs that are listed on the London Stock Exchange and have split these by region and sector in the table below so that you can see what is available to invest in.
|Sector||Global||United States||Europe||Emerging markets||Total|
Returning to our initial example of investing in US banks, investors could use either iShares S&P 500 Financials Sector UCITS ETF or Source Financials S&P US Select Sector UCITS ETF GBP if they wanted their returns to be in sterling, or SPDR S&P US Financials Select Sector UCITS ETF if they are prepared to accept currency fluctuations as the ETF is priced in US dollars.
Out of the two sterling-denominated ETFs, iShares is the cheapest with 0.15% management fee whereas the Source ETF is double the cost at 0.30%. SPDR offer the dollar-priced version at 0.15%.
For investors interested in getting exposure to some of the GICS sectors mentioned above but on a global scale, Lyxor recently reduced their management fee on all ten of their global sector ETFs to 0.30% from 0.40%.
While it is important to scrutinise the annual management fee that is charged to hold an ETF, investors should also consider liquidity, how closely the ETF has tracked its benchmark and, of course, its relative performance to similar ETFs.