New Sector ETFs, With a Twist
Blink, and another exchange-traded fund is born. ETFs, which are similar to index funds but trade on exchanges like stocks, are rapidly proliferating, as investment managers churn out products that exploit the narrowest sectors of the stock market. For example, you can now invest in a basket of companies involved in the waste-management industry, thanks to an ETF recently launched by Van Eck Global. Have you always wanted to try your hand at investing in private equity? Powershares has a new product for you: an ETF that holds shares of companies that invest in private firms. These days, you can even buy a mutual fund that invests in -- you guessed it -- ETFs.
Among the latest batch of ETFs on the market is a line of Rydex funds that track sectors within Standard Poor's 500-stock index. But these are sector ETFs with a twist. Unlike the SP 500 index, which weights each stock in proportion to its market value, these ETFs divide all stocks equally. The idea, says Rydex, is to avoid overexposure to large companies and give more weight to shares of smaller companies, many of which would be excluded or given minimal weighting in a market-value weighted index. The nine ETFs, which began trading on the American Stock Exchange on November 7, track SP indexes in the following sectors: consumer discretionary (symbol RCD), consumer staples (RHS), energy (RYE), financial services (RYF), health care (RYH), industrial (RGI), basic materials (RTM), technology (RYT), and utilities (RYU).
Rydex undoubtedly hopes this new line of funds is as successful as its flagship ETF, Rydex SP Equal Weight (RSP). The fund, which holds $1.6 billion in assets, launched in April 2003. Over the past three years to November 8, it returned 14% annualized, three percentage points per year more than the traditional SP 500 index.
A peek under the hood of one of Rydex's equal-weighted sector funds illustrates the firm's strategy. In the consumer staples ETF (RHS), Proctor Gamble represents 2.6% of assets. In a market-weighted index, the consumer-products giant would account for 17.3% of assets. In sum, a market-weighted index fund will perform better than a traditional index fund when small-company stocks outperform big-company names. The reverse, of course, is also true. When big-cap stocks dominate, you'd rather be in a traditional index fund, whether you're investing in the entire market or dabbling in segments of it.