Plain vanilla, broad market equity funds will probably always be the bread and butter of the exchange-traded funds (ETFs) industry, but over the years, advisors and investors have increased their exposure to sector ETFs. That tactic can be particularly useful for investors looking to hone in on outperforming segments while dodging laggards. That scenario is at play this year, with some sectors delivering for investors while others are not delivering anything other than disappointment.

"Gains of 18 percent for information technology and 13 percent for healthcare help mask the 13 percent and 9.5 percent losses for energy and telecom services, respectively, in a portfolio holding stakes in all 11 GICS sectors, said CFRA Research's Director of ETF and Mutual Fund Research Todd Rosenbluth in a note out Wednesday. "By focusing on getting the sector calls correct, an investor can find performance success." (See also: An Introduction to Sector ETFs.)

Now that real estate is its own sector, the Vanguard REIT ETF (VNQ), home to $34 billion in assets under management at the end of April, is the largest sector ETF. However, State Street Global Advisors (SSgA), the pioneer of sector ETFs, is the largest issuer of such funds. "SSgA pioneered sector ETF investing 19 years ago with the launching of then nine Sector SPDR products, including Financial Select Sector (XLF) and Health Care Select Sector SPDR (XLV)," said Rosenbluth.

XLF and XLV are the largest ETFs tracking the financial services and healthcare sectors. XLV was one of the nearly 15 sector ETFs that hit record highs Wednesday. XLV notched its first negative annual performance since 2008 last year, but the ETF is surging this year. Since the start of the current bull market in U.S. stocks, healthcare has been one of the best performing sectors. (See also: A Look at the Health Care Select Sector SPDR Fund.)

Perhaps aided by the Federal Reserve raising interest rates by 25 basis points on Wednesday, several ETFs tracking the industrial and materials sectors hit record highs. That includes the Industrial Select Sector SPDR (XLI) and the Materials Select Sector SPDR (XLB). XLI and XLB, the largest ETFs tracking those sectors, are each up more than 10 percent year to date. Cyclical sectors, including industrials and materials, historically perform well when interest rates rise because higher borrowing costs are seen as a sign of the Fed's confidence in the U.S. economy.

Many sector ETFs, including those issued by SSgA, Vanguard and Fidelity, are cap weighted, meaning they are dominated by the largest stocks in a particular sector. That explains in part investors' affinity for ETFs such as the Technology Select Sector SPDR (XLK) and the Consumer Discretionary SPDR (XLY). XLK features big allocations to Apple Inc. (AAPL) and Facebook, Inc. (FB), while XLY is dominated by, Inc. (AMZN). The risk with cap-weighted sector ETFs is that, when a sector's biggest components are taken to task, these ETFs participate in the downside. Tech and discretionary ETFs were not among the sector funds hitting record highs Wednesday, but XLK and XLY are still up an average of 13.9 percent year to date. (See also: Tech ETFs Feel the Outflows.)


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