Sector ETF Panel

On Thursday at 2pm EST Seeking Alpha is hosting a live panel about investing in ETFs at the sector level. The panelists are Kim Arthur, Matt Hougan, Tom Lydon and JD Steinhilber. The links in their names will take you to an article by each of them featuring their answers to the same five questions about sector ETFs which were like a primer for the panel.

While I am not participating I thought I would take a stab at most of the same questions.

1. What are the key factors you're looking for when choosing a particular ETF among many available to capture a given sector?

My take here is different than the panelists, although Tom Lydon does cover some of the ground I think is important. As I start from the top down (a couple of the panelists are also top down but maybe the logistics are different?) I figure out what exposures I want. By exposures I mean, sector weights, countries, volatilities, cap size, yield (sometimes) and style (also sometimes). From there it becomes about the best way to work these opinions into the portfolio.

For example sectors like energy and financials are easy places to add foreign exposure because just about every country has a bank and oil company. Materials can be a good way to add volatility as another example and so on. If energy is indeed a sector where foreign is to be added what then becomes the best way to do that? For me this means an assessment of countries and then how to add the preferred countries. Where there is choice those choices must be weighed against each other, how they might interact with other holdings in the portfolio and on their own bottoms up merits. Where there is only one choice that choice must be assessed and ruled in or out. If it is not obvious this process is time consuming.

2. Can you give an example of two sector ETFs that you considered, and why you chose one over the other?

Read the answers each of the panelists gives. I would focus more on what is under the hood. For example there are some sector funds that offer international exposure or other funds that combine domestic and foreign or just domestic. Additionally there are specialized, or theme funds that can also serve as a proxy for a given sector. With the industrial sector there are broader funds that are probably heavy in General Electric (GE) or other funds are heavy in Western European companies.

Another way to come at this sector then would be some of the infrastructure funds or maybe wind, solar or water funds. If you invest at the sector level you have very likely thought about these narrower groups even if they are not necessarily right for you but these are the choices in terms of funds and what you have to choose from. Anyone open to a blend of ETFs and stocks obviously has more to choose from.

3. Is ETF selection and portfolio construction something the individual investor can effectively do on their own, or given the complexities and the dynamic nature of this market, do you think it's best left to a professional?

As I have said repeatedly; for most people, I believe this boils down to time available to spend on the task.

5. What are your thoughts on the relatively new actively managed ETFs? If an investor is interested in purchasing an actively managed ETF, what are the important elements to look for?

The general thing with actively managed products that I don't like is that you do not know what it will own in six months making it very difficult to implement forward looking analysis. This issue is not as big of a deal with an actively managed sector fund. You know that an actively managed global utilities fund will always own utilities stocks. You wouldn't know what countries you would own six months from now but leaving that to a manager you believe can add value might not be the worst thing in the world.

I'll conclude by circling back to a couple of things. Understanding how a fund is likely to behave is crucial. Chances are a solar fund will be much more volatile than a mega cap dominated fund for example. This is neither good nor bad, it just is. If you build a portfolio at the sector and country levels you need to understand the dynamics of the sectors and countries, have a sense of the holdings in the funds and understand the volatility characteristics of the funds.

To repeat a point I make a lot, the only thing easy about ETFs (beyond SPY and IWM) is the access.