ETFs: the new stock substitute
Today, my first day back from vacation, I had an interesting meeting with Dan Dolan, who runs a group of nine exchange traded funds (ETFs), known as Select Sector SPDRs ("spiders"). Combined, these nine sector funds comprise all the stocks in the S&P 500 Index. They total $10.5 billion in assets, up from $9.4 billion at the end of 2004 and volume is up to 100 million shares traded a day.
Dolan told me about new ways investors are using these sector-specific ETFs. One theory he has is that they are becoming a substitute for buying individual stocks.
For example, let's say you want to invest in a trend -- like the aging of the baby boomers. But you don't want to purchase a specific healthcare company, spooked by recent implosions of stocks like Merck or Biogen.
So, instead you just buy the Healthcare SPDR (XLV). There are 55 stocks in the index, but four stocks make up 40% of assets. As of March 24 (the holdings are updated daily at www.sectorspdrs.com), the top names are Johnson & Johnson (14%), Pfizer (14%), Amgen (5.2%), and Merck (5%).
Another scenario: Let's say you would like to own General Electric, but you don't want to place too big a bet on one company. Buy the Industrial SPDR (XLI) and 22% of your investment is GE. The Consumer Staples SPDR is 16% Wal-Mart. The Energy SPDR is 21% Exxon Mobil.
Basically a sector ETF creates a way to get extra diversification while still making a play on a specific investment theme or company, says Dolan. Even though ETFs are used primarily by traders, they are a good option for buy and hold investors, he argues. And, based on the fees alone they are worth a look over actively-managed sector mutual funds.