Sector ETFs are booming. Assets under management are up more than 45% between December 2004 and November 2005, according to the most recent statistics available from the Investment Company Institute. The largest of the sector offerings, the nine Select Sector SPDR funds, have seen their assets more than double to $13 billion since mid-2003; the largest of the group, the Energy Select Sector SPDR Fund, now boasts almost $4 billion in assets following a New Year's surge. But these broad-based sector funds find themselves crowded by funds with smaller ambitions, covering increasingly specialized slices of the market.
The industry's two biggest players, Barclays Global Investors and State Street Global Advisors, are preparing a big push into sub-sector ETFs this year, with more than a dozen funds in registration between them, to go with the better than 20 new sub-sector funds that hit the market last year.
"People find them very useful tools for risk adjustment," says James Parsons, head of sales at BGI.
But the glut of funds, many covering the same sub-sectors, has a cohort of skeptics concerned about saturation who are questioning the viability of such a wide array of niche investments.
"I'm not sure, if you get too many oil and gases, how well they're going to do," says Paul Mazzilli, an ETF expert for Morgan Stanley. At the same time, "its not something like gold, where there's been pent-up demand for a year," giving the first to market a big advantage.
Another question plaguing many investors is how such narrowly constructed funds will fit into an asset allocation strategy. "You're going to have to have a really defined asset allocation model to get into three slices of the financial sector in addition to four slices of health care. Most people do not have that," says Dan Dolan, director of wealth management at the Select Sector SPDR Trust. Though Dolan has presided over the SSgA-sponsored sector SPDR's huge increase in assets under management over the last several years, he isn't sure the money coming into broad-based sector funds will support more specialized offerings.
"What's frustrating for me is that we have spent a lot of time talking about sector investing in the sense of asset allocation," Dolan says with a laugh. "I think a lot of what's going on today in the further slices is taking it away from asset allocation to chasing performance."
Other industry experts think the time has come for a full menu of sub-sector funds. For instance, the SPDR-style broad-based sector funds "are always going to garner assets," says PowerShares Capital Management President Bruce Bond. "But in time, the more sophisticated investors are going to want to be more specific than that, and [the SPDR-style broad based funds] are going to be too broad for most of them."
Clearly the appetite for sub-sector investing is growing, as investors realize it offers a palatable alternative. HOLDRs, exchange-traded depositary receipts created by Merrill Lynch, track a number of hot sub-sectors, including biotechnology, oil services, pharmaceuticals, banks and semiconductors, which the ETF crowd is eager to join. It's no wonder why: the Semiconductor HOLDRs have traded better than 10 million shares per day since the New Year, with assets of $1.5 billion; the Oil Services HOLDRs also has daily volume in the millions with assets of $2.2 billion. But HOLDRs aren't for everyone; they are expensive, and must be bought and sold in 100 share lots, making the minimum initial investment in the biotech HOLDR, for example, a whopping $20,000.
"As ETFs have become more popular, people are just looking for more specific plays," says Morgan's Mazilli. What's more, "the ones that they're coming out with are all of interest to investors." Morgan Stanley is advising BGI on its upcoming offerings.
Among those sectors are biotech (SSgA has a fund in the works), oil services (BGI) and semiconductors (SSgA again). All three of those industries are tracked by some of the most widely traded HOLDRs; they are also areas that PowerShares already has an offering.
In fact, in most cases, the new funds from BGI and SSgA will not be the first of their kind to market. PowerShares, the leader in terms of the number of sub-sector funds, is already there, with offerings covering energy exploration and production, oil services, pharmaceuticals, insurance, aerospace and defense, and building and construction all launched last year. SSgA is also slightly ahead of the curve, having put out three financial sub-sector funds in November, tracking subindices from investment bank Keefe, Bruyette & Woods.
"Our clients have been telling us there's a need out there for more granularity in the sector market," says Dave Sandrew, head of ETF sales for SSgA. "We've seen a lot of liquidity come into these products... There's a real appetite out there."
"To the extent that the choice is true choice, it's good for the market," adds BGI's Parsons.
So far, asset gathering bears that out, to some extent. In its first six months, PowerShares' Dynamic Biotechnology & Genome Portfolio has racked up more than $160 million in assets. The streetTRACKS KBW Bank ETF covering capital markets has garnered $113 million in less than two months, while the other two KBW ETFs, banks and insurance, have topped $60 million each. The other existing PowerShares funds about to get some company – energy exploration, pharmaceuticals, aerospace and defense, and building and construction – have had a more lukewarm reception, garnering between $35 and $60 million apiece. PowerShares also has another group of funds with between $20 and $35 million AUM.
Still, some of these numbers are staggering for such new investments. While asset allocators may not be big players in sub-sector ETFs, someone is clearly trading them, namely, hedge funds. Sandrew estimates that up to 70% of ETF flows coming through investment banks is from hedge funds looking for quick exposure. The turnover on some of the HOLDRs can be as short as a day or two, adds Mazilli. But insiders say interest has been "bubbling up across the board," from Securities and Exchange Commission-regulated funds looking for cash equitization from sectors, and wrap programs looking for a more sophisticated allocation strategy.
It's also about being there when (or if) investors do come around. Powershares is building an entire industry group product offering, "so that people know that they can come to us, and we're going to give them exposure to the specific area they want exposure to," Bond says. "Investors are going to want to be more specific, and it is only a matter of time before we start to see those kinds of things happen,"
Sandrew promises that "the sub-sectors are not going to go away." But will investors reward their faith sooner, or later?
The industry's two biggest players, Barclays Global Investors and State Street Global Advisors, are preparing a big push into sub-sector ETFs this year, with more than a dozen funds in registration between them, to go with the better than 20 new sub-sector funds that hit the market last year.
"People find them very useful tools for risk adjustment," says James Parsons, head of sales at BGI.
But the glut of funds, many covering the same sub-sectors, has a cohort of skeptics concerned about saturation who are questioning the viability of such a wide array of niche investments.
"I'm not sure, if you get too many oil and gases, how well they're going to do," says Paul Mazzilli, an ETF expert for Morgan Stanley. At the same time, "its not something like gold, where there's been pent-up demand for a year," giving the first to market a big advantage.
Another question plaguing many investors is how such narrowly constructed funds will fit into an asset allocation strategy. "You're going to have to have a really defined asset allocation model to get into three slices of the financial sector in addition to four slices of health care. Most people do not have that," says Dan Dolan, director of wealth management at the Select Sector SPDR Trust. Though Dolan has presided over the SSgA-sponsored sector SPDR's huge increase in assets under management over the last several years, he isn't sure the money coming into broad-based sector funds will support more specialized offerings.
"What's frustrating for me is that we have spent a lot of time talking about sector investing in the sense of asset allocation," Dolan says with a laugh. "I think a lot of what's going on today in the further slices is taking it away from asset allocation to chasing performance."
Other industry experts think the time has come for a full menu of sub-sector funds. For instance, the SPDR-style broad-based sector funds "are always going to garner assets," says PowerShares Capital Management President Bruce Bond. "But in time, the more sophisticated investors are going to want to be more specific than that, and [the SPDR-style broad based funds] are going to be too broad for most of them."
Clearly the appetite for sub-sector investing is growing, as investors realize it offers a palatable alternative. HOLDRs, exchange-traded depositary receipts created by Merrill Lynch, track a number of hot sub-sectors, including biotechnology, oil services, pharmaceuticals, banks and semiconductors, which the ETF crowd is eager to join. It's no wonder why: the Semiconductor HOLDRs have traded better than 10 million shares per day since the New Year, with assets of $1.5 billion; the Oil Services HOLDRs also has daily volume in the millions with assets of $2.2 billion. But HOLDRs aren't for everyone; they are expensive, and must be bought and sold in 100 share lots, making the minimum initial investment in the biotech HOLDR, for example, a whopping $20,000.
"As ETFs have become more popular, people are just looking for more specific plays," says Morgan's Mazilli. What's more, "the ones that they're coming out with are all of interest to investors." Morgan Stanley is advising BGI on its upcoming offerings.
Among those sectors are biotech (SSgA has a fund in the works), oil services (BGI) and semiconductors (SSgA again). All three of those industries are tracked by some of the most widely traded HOLDRs; they are also areas that PowerShares already has an offering.
In fact, in most cases, the new funds from BGI and SSgA will not be the first of their kind to market. PowerShares, the leader in terms of the number of sub-sector funds, is already there, with offerings covering energy exploration and production, oil services, pharmaceuticals, insurance, aerospace and defense, and building and construction all launched last year. SSgA is also slightly ahead of the curve, having put out three financial sub-sector funds in November, tracking subindices from investment bank Keefe, Bruyette & Woods.
"Our clients have been telling us there's a need out there for more granularity in the sector market," says Dave Sandrew, head of ETF sales for SSgA. "We've seen a lot of liquidity come into these products... There's a real appetite out there."
"To the extent that the choice is true choice, it's good for the market," adds BGI's Parsons.
So far, asset gathering bears that out, to some extent. In its first six months, PowerShares' Dynamic Biotechnology & Genome Portfolio has racked up more than $160 million in assets. The streetTRACKS KBW Bank ETF covering capital markets has garnered $113 million in less than two months, while the other two KBW ETFs, banks and insurance, have topped $60 million each. The other existing PowerShares funds about to get some company – energy exploration, pharmaceuticals, aerospace and defense, and building and construction – have had a more lukewarm reception, garnering between $35 and $60 million apiece. PowerShares also has another group of funds with between $20 and $35 million AUM.
Still, some of these numbers are staggering for such new investments. While asset allocators may not be big players in sub-sector ETFs, someone is clearly trading them, namely, hedge funds. Sandrew estimates that up to 70% of ETF flows coming through investment banks is from hedge funds looking for quick exposure. The turnover on some of the HOLDRs can be as short as a day or two, adds Mazilli. But insiders say interest has been "bubbling up across the board," from Securities and Exchange Commission-regulated funds looking for cash equitization from sectors, and wrap programs looking for a more sophisticated allocation strategy.
It's also about being there when (or if) investors do come around. Powershares is building an entire industry group product offering, "so that people know that they can come to us, and we're going to give them exposure to the specific area they want exposure to," Bond says. "Investors are going to want to be more specific, and it is only a matter of time before we start to see those kinds of things happen,"
Sandrew promises that "the sub-sectors are not going to go away." But will investors reward their faith sooner, or later?
