Thinking About ETFs, Sector Weightings and Portfolio Exposure

 |  Includes: CHXX, EPOL, MES
by: Roger Nusbaum

The other day I was interviewed for an article about ETFs. Part of the conversation was the way I look under the hood and thinking about an ETF (or individual stock for that matter) as being a proxy for different things or part of the exposure for some segment.

Succinctly this means taking into account the sector weightings of a country fund, country weightings of a sector fund and both country and sector weightings in a thematic fund. Failure to do so is how people ended up 50% in tech in 2000 or 40% in financials in 2007.

This only seems logical to me, and something I have been writing about for a long time now, but was new to the interviewer. Of course other people take these things into consideration but maybe the point is that not enough people do.

Fund screening in this context is simple spreadsheet work, or Morningstar can do it for you with its portfolio tool. A portfolio that combines stocks, thematic funds, country funds and sector funds will have some weighting in each sector and some number of countries. What are those weightings, and is that where you want to be positioned?

Taking a simplistic example, a portfolio consisting of iShares Poland ETF (NYSEARCA:EPOL), Market Vectors Gulf States Index ETF (NYSEARCA:MES) and EG Shares China Infrastructure ETF (NYSEARCA:CHXX) would seem to cover a lot of divergent ground. EPOL has 40% in financials, MES has 65% in financials (including real estate) and CHXX has 23% in real estate (which I consider to be part of financials). Obviously if someone wants that much in financials then there is no potential issue of being blindsided (only a potential issue of being wrong).

The lopsided exposures in these funds is not by itself a negative. If MES were 100% financials then a 5% portfolio weight in the fund would obviously be 5% of the portfolio in financials. Someone wanting a total of 15% could compile the other 10% for financials from other funds and/or individual stocks. For someone only using funds it might be difficult to get to each sector target exactly as hoped for but they can get reasonably close. If 10% is the desired weight, I don't think 8% or 12% would be ruinous. Wanting 10% and ending up with 40% might be.