What Are They?
- Quant strategy sector ETFs provide exposure to US sectors via a basket of stocks determined by rules-based quantitative analysis, such as "overweight stocks with low P/E ratios" or "overweight stocks that have beaten earnings estimates for three quarters running".
- The PowerShares ETFs select stocks based on undisclosed valuation criteria. The underlying stock baskets are recalibrated every quarter.
- These ETFs aren't entirely market cap weighted or equal weighted. 60% of the basket is devoted to a group of large cap stocks and 40% to mid and small cap stocks. But within the market cap-defined groups, the stocks are equal weighted, with each large cap stock given a 2.5% weighting and each mid and small cap stock a 1.36% weighting.
Why & How To Use Them
- Use these ETFs instead of regular index sector ETFs if you believe that quantitative, rules-based stock selection will outperform a market cap weighted or equal cap weighted index.
- There are three ways to use sector ETFs: (1) for short term trading, (2) to overweight one or a couple of sectors in a long term portfolio by adding a single sector ETF to a portfolio of broader ETFs, or (3) as the basic building blocks of a long term portfolio. Quant strategy sector ETFs are arguably less suitable for short term trading than longer term investment strategies because the underlying basket of stocks isn't knowable.
- The argument for using sector ETFs as the basic building blocks of a portfolio is that doing so makes your portfolio more granular, providing more rebalancing opportunities.
What to Look Out For
- Compared to broader index ETFs, specialty ETFs such as quant strategy sector ETFs, tend to have higher expense ratios and wider buy-sell spreads (which makes them more costly to purchase and sell).
- The quarterly recalibration of the stock baskets underlying these ETFs leads to higher stock turnover and therefore potentially higher trading costs and lower tax efficiency.
- Articles on ETFs mentioned here: Claymore's New Rotation ETFs: A One-Stop Approach To Country Investing and Income Growth (Matt Hougan), First Trust Launches AlphaDEX Family of Quant ETFs (Matt Hougan).
- For more on PowerShares, see Mick Weinstein's PowerShares: Growing Assets But With High Expense Ratios.
- Types of sector ETFs: Global Sector ETFs, Foreign Sector ETFs, Primary US Sector ETFs, Equal Weight Sector ETFs, Quant Strategy Sector ETFs, Fundamental Sector ETFs and Leveraged Sector ETFs.
This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.