Sector ETF Investing Advantages and Disadvantages : NobleTrading Blog

Monday, April 6, 2009

Sector ETF Investing Advantages and Disadvantages

There are now a number of types of Exchange Traded Funds (ETFs) available to choose from. Sector ETFs which track one or more sectors like energy, financials, industries, health care, utilities, technologies, etc. and broad market based ETFs are two broad ETF types available. Here are some advantages and disadvantages of investing in sector ETFs over broad market based ETFs.

Advantages of Sector Based ETFs

Investors can profit from market sectors which are expected to outperform other sectors or of which stocks are undervalued.
The portfolio can be fine tuned according to investor needs; for managing portfolio returns, risks or diversification.
Buy-low and sell-high strategy can be better implemented with sector ETFs than broad-based ETFs.
Carefully investing in liquid and broad sectors can help the investors to profit from the market, even if the market is falling.
Investors can also perform sector ETF rotation strategies to profit from changing economic conditions.
Availability of different weight sector ETFs (Market weighted, equally weighted and fundamentally weighted) and smart/leveraged ETFs offer greater flexibility for traders.

Disadvantages of Sector Based ETFs

Sector based ETFs tend to have higher expense ratio than broad-based ETFs.
They are less liquid than broad-based ETFs and thus the ask-bid spread can be wider, causing higher trading costs.
They offer lesser diversification and thus not suited for investors who want to invest their small amount of money in broad (higher liquid and diversified) markets.
Trading costs can also increase if the trader buys and sells the ETFs frequently, is following sector rotation strategies and/or want to diversify portfolio by investing in many sectors.
Sector ETF investing needs good fundamental analysis and market understanding and can be time consuming. More over no one can exactly predict which sector is going to outperform and which is going to under perform.