Exchange Traded Funds Offer Opportunity

Exchange Traded Funds are assumed to be the hot money as it rotates into the sectors and sub-sector opportunities. The rise of press on this topic is interesting and it corresponds to the growth or rising amount of money flowing into ETFs. Depending on your bias you will either like ETFs and the opportunities they offer or you will think they are the Darth Vader of the trading markets. The debate relative to the usefulness of ETFs versus  mutual funds has become an expected controversy that iis building. Investors can use both tools to capture the sector rotation opportunities of the broad markets. ETFs offer the average investor a real time way of scanning the market, building watch lists and digging into ETFs to find the leading stocks in those sectors. Mutual funds are viewed more for longer term investments to capture alpha through the use of professional managers. Whatever your belief use them for what they are and you will find plenty of opportunities in both products.

Money flows for ETFs are up since January as risk is being sought by investors. StateStreet fund reports show money flow into ETFs are on pace to be up nearly two times what they were in 2011. They have grown by net inflow of $34 billion since the first of the year. Equity ETFs have added just over $22 billion and $8.8 billion has poured into fixed income ETFs. Emerging markets are another big winner gaining more than $9 billion. This type of activity is good for ETF providers, but more importantly shows the willingness of investors to elevate risk when markets are moving higher. The transparency of the funds attract investors as well as the ease of trading. The evolution of ETFs continues, but the challenge for investors is volume. There are nearly 1300 ETFs today, but the volume is concentrated it the top 150 funds. Liquidity remains the number one hindrance to many of these funds. That aside, they do offer great insight into the rotation of assets relative to the sectors and asset classes they measure.

With that in mind, Apple is continuing to invite speculation on how high it will go. The weighting of Apple relative to the indexes is getting noticed. It now accounts for 16.5% of the NASDAQ 100 index. Some are pointing to the ETFs which have 18 or 20% exposure to Apple as a bad thing, what does that say for the NASDAQ 100 index. Apple is the primary reason the index has outperformed over the last eight weeks. To put it in perspective ONEQ, Fidelity NASDAQ Composite Index Tracking ETF has 1963 stocks of which Apple accounts for 9.6% of the weighting. There are 2782 stocks in the NASDAQ composite index itself and the weighting is 9.3% to Apple. This type of data shows the research insight that ETFs provide the investor. It is easier to drill down and find data and opportunities from ETFs that can be used to build and manage your portfolio.

You can develop your own strategy for sector rotation using ETFs. An example is the S&P 500 index has ten sectors. SPDRs Select Sector ETFs has all ten sectors in corresponding ETFs. (XLB, XLY, XLP, XLV, XLF, XLE, XLK, XLU, XLI, XTL) You can assign each of these the current weighting to match the S&P 500 index overall. Equally you can overweight, underweight or eliminate the sectors based on your research and strategy relative to the benchmark. Thus, you could have your own portfolio that rotates in and out of the sectors you want to own in relationship to the index and the risk you are willing to accept. We have run a portfolio of assets on this strategy with the objective to add alpha or outperform the benchmark S&P 500 index. For example, the portfolio is currently overweight to the technology sector based on what we discussed above, Apple is pushing the indexes higher by the weighting of the stock in the index. In addition we have been overweight financials based on the growth in the sector and positive outlook near term. It is underweight basic materials and has no weighting to utilities currently. By managing the parts that make up the whole we can control the sector exposure to our strategy and risk tolerance. Thus, ETFs empower the investor to build portfolios and strategies that they control relative to risk and desired exposure to sectors or asset classes.

As an investor the primary objective is to make money. I would add to that, to make money and control the strategy and risk of doing so. Not everyone wants or needs to be fully exposed to the risk of the markets one hundred percent of the time. Exchange Traded Funds allow you, the investor, to visualize the market in parts, build strategies to capture the part you want to own and eliminate the parts you don’t. As with any investment product there are good and bad characteristics of these funds. Use them for what they are, and as the saying goes, “if the shoe fits, wear it.”