PowerShares New Sector ETFs

Roger Nusbaum submits: The gang over at PowerShares rolled out a bunch of sector ETFs based on Robert Arnott's method of fundamental weighting. I am sure some people will immediately say we have enough sector ETFs, and maybe we do, but from where I sit if only one or two of them provide a better way to access a sector, and the rest turn out to be duds, that is OK.

Quite a few of the PowerShares product line does well, performance-wise, and draws a lot of volume. Their success allows them to venture further out and try new ideas. I saw Robert Arnott speak at the NYSE last December, and I asked about this methodology being applied to foreign countries. He said yes, and also various sectors, which we are seeing today.

The new ETFs are:

• PowerShares FTSE RAFI Basic Materials ETF (PRFM)
• PowerShares Consumer Goods ETF (PRFG)
• PowerShares Consumer Services ETF (PRFS)
• PowerShares Energy ETF (PRFE)
• PowerShares Financial ETF (PRFF)
• PowerShares Healthcare ETF (PRFH)
• PowerShares Industrial ETF (PRFN)
• PowerShares Telecom ETF (PRFQ)
• PowerShares Utilities ETF (PRFU)
• PowerShares Small-Mid 1500 ETF (PRFZ)

Obviously that last one is not a sector fund.

I will study all of these in the next few weeks, but looking at one random fund I picked the Industrial Fund. According to their info sheet, General Electric Co. (GE) is the largest component at 21%. Yikes. GE is the largest holding in every industrial ETF. It makes up 18.5% of the Industrial SPDR ETF (XLI), 19.5% on Vanguard Industrials ETF (VIS), and 19.8% of iShares Dow Jones US Industrial ETF (IYJ).

I'll look at these closer, but I will say that I am surprised at the lack of differentiation between PRFN and the others.

Comments

[Internet2k4:]

Not being an Arnott scholar, I could be missing it, but it seems logical to me that "fundamental" weighting would naturally correlate pretty closely with market cap within the confines of narrow sectors - the cream rises to the top and the market will buy stocks in the sector on their fundamentals. Off the top it would seem Arnott would be more useful (in theory, assuming the fundamental analysis used is actually sound) and maybe even repay the MER premium within broader market indices, where the method would result in balancing off sectors themselves.

2006 Sep 21 09:01 AM

[Roger Nusbaum:]

I am not aguing with you just passing along what Arnott would say.....Weighting by cap size creates a bias toward growth over value. The Fundamental indexing process is supposed to remove that bias. Value tends to out perform, not always and the should tilt to value most of the time

2006 Sep 21 05:07 PM

[mslasky:]

The existence of fundamental ETF's will increase demand for those equities with "value" characteristics. Increased demand, constant supply, increased prices. So in the short term (say 3 yrs?) the price will rise for equities with good fundamentals, thus tending to decrease their value, as their prices rise. I see this as more of a trading opportunity! Their 45 year back-testing is impressive, but leaves out the impact these new fund's themselves will have on the price/value differentials that did exist in the past.

2006 Sep 24 11:06 AM