“You cannot invest in an index” is the standard disclosure that accompanies any index returns when used as a performance benchmark. Therefore, I try to avoid the use of indexes whenever possible. To me, it makes much more sense to look at vehicles that you can invest in—such as index-based exchange-traded funds (“ETFs”). This makes ETFs such as the SPDR S&P 500 (SPY), iShares Russell 2000 (IWM), PowerShares QQQ (QQQ), and iShares MSCI EAFE (EFA) better performance representatives than their underlying indexes. When analyzing U.S. sector performance, ETFs are once again the better choice. That is where sector benchmark ETFs can play a role.
Contrary to many analysts, I do not base my sector analysis on the Select Sector SPDRs. To me, this family has two major shortcomings. First, the suite does not correctly represent all 11 sectors of the Global Industry Classification Standard (“GICS”). Instead, it tucks the stocks belonging to the Telecommunications sector inside the Technology ETF. Secondly, these ETFs limit their holdings to just the stocks within the S&P 500 Index, depriving investors of exposure to small- and mid-cap stocks.
In my opinion, the Vanguard suite of sector ETFs provide better benchmarks. They follow the GICS classification system and encompass more than 2,500 stocks, representing about 97% of the entire U.S. market capitalization. These 11 ETFs have combined assets of $100 billion, with the smallest one holding $1.4 billion. Additionally, they are all very liquid (highly tradeable) and carry an expense ratio of just 0.10% (except where noted). Vanguard introduced most of these ETFs in 2004 as alternative share classes to its sector mutual funds, which have an even longer history.
Listed in order of their percentage allocations of the U.S. market capitalization, the Vanguard suite of sector ETFs and my sector benchmark ETFs consist of the following:
Vanguard Information Technology (VGT): Representing about 20.0% of the U.S. market, this ETF currently holds 373 stocks and has a yield of 1.3%. Top industry allocations include Internet Software & Services 19.8%; Hardware, Storage, and Peripherals 15.3%; Systems Software 14.2%; Semiconductors 13.8%; Data Processing & Outsourced Services 11.4%; IT Consulting 6.6%; Application Software 6.0%; and Communication Equipment 5.6%.
Vanguard Financials ETF (VFH): Representing about 15.5% of the U.S. market, this ETF currently holds 402 stocks and has a yield of 1.9%. Top industry allocations include Diversified Banks 30.2%, Regional Banks 15.2%, Property & Casualty Insurance 7.7%, Asset Management & Custody 7.4%, Investment Banking & Brokerage 7.0%, Consumer Finance 5.5%, and Life & Health Insurance 5.5%.
Vanguard Health Care (VHT): Representing about 12.9% of the U.S. market, this ETF currently holds 367 stocks and has a yield of 1.5%. Top industry allocations include Pharmaceuticals 32.9%, Biotechnology 22.7%, Health Care Equipment 17.4%, Managed Health Care 10.6%, and Life Sciences Tools & Services 5.1%.
Vanguard Consumer Discretionary (VCR): Representing about 12.5% of the U.S. market, this ETF currently holds 386 stocks and has a yield of 1.3%. Top industry allocations include Internet & Direct Marketing Retail 16.0%, Cable & Satellite 10.5%, Movies & Entertainment 10.1%, Restaurants 10.0%, Home Improvement Retail 7.5%, Apparel Retail 4.8%, and Automobile Manufacturers 4.2%.
Vanguard Industrials (VIS): Representing about 10.9% of the U.S. market, this ETF currently holds 352 stocks and has a yield of 1.8%. Top industry allocations include Aerospace & Defense 19.7%, Industrial Conglomerates 19.1%, Industrial Machinery 10.2%, Air Freight & Logistics 6.2%, Railroads 6.4%, Construction Machinery & Heavy Trucks 5.6%, Airlines 5.5%, and Electrical Components & Equipment 5.1%.
Vanguard Consumer Staples (VDC): Representing about 8.2% of the U.S. market, this ETF currently holds 104 stocks and has a yield of 2.6%. Top industry allocations include Packaged Foods & Meats 18.8%, Household Products 18.1%, Soft Drinks 17.1%, Tobacco 15.3%, Hypermarkets & Super Centers 8.9%, and Drug Retail 8.1%.
Vanguard Energy (VDE): Representing about 7.0% of the U.S. market, this ETF currently holds 133 stocks and has a yield of 2.3%. Top industry allocations include Integrated Oil & Gas 37.8%, Oil & Gas Exploration & Production 28.5%, Oil & Gas Equipment & Services 15.7%, Oil & Gas Storage & Transportation 8.2%, and Oil & Gas Refining & Marketing 7.7%.
Vanguard REIT (VNQ): Representing about 3.9% of the U.S. market, this ETF targets the Real Estate sector, currently holds 157 stocks, has a yield of 4.0%, and comes with an expense ratio of 0.12%. Top industry allocations include Retail REITs 23.2%, Specialized REITs 15.8%, Residential REITs 15.5%, Office REITs 13.5%, Health Care REITs 11.9%, and Diversified REITs 7.3%.
Vanguard Materials (VAW): Representing about 3.4% of the U.S. market, this ETF currently holds 125 stocks and has a yield of 1.8%. Top industry allocations include Specialty Chemicals 22.6%, Diversified Chemicals 18.7%, Fertilizers & Agricultural Chemicals 9.3%, Paper Packaging 9.0%, Industrial Gasses 8.2%, Steel 7.1%, Commodity Chemicals 6.3%, and Construction Materials 5.0%.
Vanguard Utilities (VPU): Representing about 3.1% of the U.S. market, this ETF currently holds 77 stocks and has a yield of 3.6%. Top industry allocations include Electric Utilities 57.4%, Multi-Utilities 30.2%, Gas Utilities 5.7%, and Water Utilities 3.3%.
Vanguard Telecommunication Services (VOX): Representing about 2.4% of the U.S. market, this ETF currently holds 30 stocks and has a yield of 3.1%. Top industry allocations include Integrated Telecommunications Services 65.6%, Alternative Carriers 19.1%, and Wireless Telecommunications Services 14.9%.
Disclosure: At the time of this writing, author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned