Thursday, July 16, 2009

Be careful when choosing your ETF

Alpha Ninja - Sector ETF's are a great tool for investors to narrow their approach. The options are vast, and the management fees are very cheap. You can gain exposure to a particular sector that you know a lot about, or you think is out of favor and due to outperform the general market.

It's important to dig into the holdings before investing in these, because there are major differences among them. For an example, here are two retail ETF's - symbols XRT and RTH. The XRT, run by State Street Global Advisors, has beaten the Merill Lynch-run RTH by about 10% over the past year, and at times the performance disparity has been huge.

A look at the holdings explains why. Though they're both "retail" funds, the holdings are vastly different:

In the RTH, Walmart and Home Depot account for 34% of the entire index. Whether that's bad for diversification (I think it is) is beside the point. In the XRT, Walmart's weight is 1.58% and Home Depot is not even in the fund!

These are great vehicles if you use them properly, but the holdings in them can be very different even though the names of the funds are nearly identical. Choose wisely...

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