Different Types of Sector ETFs : NobleTrading Blog

Tuesday, March 31, 2009

Different Types of Sector ETFs

One can classify sector Exchange Traded Funds (ETFs) into different categories based on its construction and its management. Below are different types of sector ETFs.

Market Weight Sector ETFs – are sector ETFs which are constructed based on market capitalization for the sector/industry/index it is tracking. These sector ETFs tend to biased towards large-cap stocks (and poorly tack small cap stocks) as in most sectors most of the market is capitalized by a handful of big companies. Advantages include high liquidity, less downside risk and good overall market exposure.
Equal Weight Sector ETFs – are sector ETFs which are constructed by assigning equal weight to all stocks in a sector/industry. They tend to outperform market weight ETFs when the small caps are outperforming large cap stocks. Advantages include better reward and better instruments for short-term trading. But as most equal weight ETFs have periodic rebalancing of portfolio, they have high expense ratio.
Fundamentally Weighted Sector ETFs – are sector ETFs constructed based on fundamentals of stocks in the sector. Undervalued stocks which strong fundamentals tend to get more weight. Advantages include better risk to return. As the companies’ fundamentals change frequently, these ETFs needs regular portfolio rebalancing and thus can be expensive.
Leveraged Sector ETFs – are sector ETFs which tend to outperform market movements by using leverage (using options and futures). The effect is similar to trading on margin; both profits and losses are magnified. They are good for short-term trading but tend to have very high expense ratios and have high downside risk.