I was recently struck by an advertisement for Select Sector SPDRs – exchange traded funds with a sector focus. This particular ad was for the XLV, the Health Care Sector SPDR ETF. “Tired of experimenting with your equity investments?,” the ad asked.
It was a valid question that we here at Bloodhound ask reqularly. To many, XLV represents a great Super Bowl where the Packers defeated the Steelers 31-25. However, as a fund that has 60% of its assets in 10 healthcare stocks, we aren’t sure that is really the answer to that question posed? The XLV is approximately a $40 stock. Gilead Sciences, the tenth largest allocation, represents 2.55% of the portfolio. Gilead has resided for a number of years as one of the top performing biotech companies researching the HIV virus. Although as the market for their HIV cocktail begins to mature and thus slow, Gilead has gone on an acqusition spree to diversify. They have bet the ship on the success of its new venture in solving Hepatitis C. Year-to-date, GILD is up almost 50%. However, another 50% increase in GILD from here would only equate to a $0.50 move in the XLV. Instead, 25% of the fund is tied to the performance of J&J and Pfizer. Hardly an “answer” for tired experimentation.
The SPDR Sector Funds are individually crafted industry baskets for consumer discretionary, consumer staples, utilities, financial, technology, health care, energy, industrial and materials groups. It would seem to me that for any of these funds to be an answer to the advertisement’s question, one would need to be an excellent market timer and asset allocator. The track record of anyone in that field is sketchy at best, and for the indivudual investor, is often quite poor.
The ad notes the following benefits for adding the XLV to your portfolio, exposure to the health care sector (check), the same diversification as mutal funds (sort of check), liquidity (check), transparency (check), and … all-day tradability of stocks. Wait, what? That line struck me the most. Although technically a benefit, what is that really saying?
Mutual funds are not for those with instant gratification needs. You place an order for a mutual fund and it is executed at the NAV at the close of the day. ETFs trade relatively instantaneously. You can place limit orders on ETFs in order to allow you to execute at the levels at which you care. That is surely a toutable benefit. However, the phrase, “all-day tradability of stocks” says something else to me. It appears that the SPDR Select Fund is targeting a subset of investors that they rarely like to admit they are catering to – the day trader.
ETFs have become a popular and cheap way to diversify or hedge positions, and a number of critics complain that they are being misused.
“They’re a wonderful tool if you’re an institutional manager trying to hedge risk. They’ve made it cheap and accessible for professional money managers to hedge risk in a portfolio. But you’re throwing gasoline on a fire when a retail investor can put their money in an ETF and expect great results,” says Doug Kreps, managing director of Fort Pitt Capital Group.
Day trading of ETFs has become the industry’s dirty little secret, and industry sector funds are the most useful tools in terms of liquidity, tradability and focus. TradingMarkets.com markets a strategy for ETF day-trading. They note, “the number one reason to day-trade is to avoid overnight risk. By taking positions in the market on an intraday basis and exiting on or before the close, traders using day-trading strategies eliminate one major source of risk for that portion of their portfolio devoted to day-trading, and lower overall portfolio risk…. ‘What this is doing,’ said Larry Connors, founder of TradingMarkets, ‘is taking advantage of the volatility that exists in the marketplace.’”
Yahoo! Finance ran an article earlier this Summer suggesting the 17 best ETF funds for day trading.
Vanguard funds published a paper supporting that their ETF holders were long-term investors. However, in that same study, it was apparent that ETF holders are significantly more short-term oriented than that of its mutual funds. Almost 40% of Vanguard ETF holders were not buy-and-hold investors, which was double the rate of its mutual funds.
A large swath of ETFs are illiquid, and the more liquid ones are clearly being targeted for day trading. As such, are individual investors suited to be trading ETFs? We have argued at Bloodhound that investors are better off building their own long-term strategies and executing those strategies with direct equity investment.