Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Rebecca Chesworth, SPDR ETF Senior Strategist looks at sector picks offer investors chances for enhanced yield.
As investors continue their search for yield, sector investing has enjoyed a resulting boost. Recent analysis by SPDR, State Street Global Advisor's ETF business, showed that there has been a fivefold increase in global assets of sector exchange traded funds (ETFs) since 2008, reaching $394 billion in assets under management at the end of 2016, with $35 billion inflows last year alone.
The US experienced the greatest growth, where there was a 548% increase in sector ETF assets with $30 billion in flows last year. However, Europe came a close second with a 487% increase in sector ETF assets and $3 billion in total flows in 2016.
By investing in an entire sector, investors gain exposure to greater diversity of returns and reduce single stock risk, whilst achieving a much wider dispersion return than style indices. A sector rotation strategy allows investors the potential to benefit from more predictable economic trends likely to impact certain industries. With political uncertainty defining 2017 and the macroeconomic backdrop shifting, the popularity of sector investing is highly likely to continue.
Since 2008, the top three sector ETFs for investors globally have been technology sector ETFs with a 1185% increase in total assets under management; followed by real estate sector equity ETFs with a 919% rise; and then energy equity ETFs, which underwent a 599% growth.
In the seven months to the end of July, sector ETFs have gathered nearly $30 billion in net inflows. This has largely been driven by the Financials sector, which had gathered almost a third of the flows at $8.4 billion.
The biggest inflows came at the start of the year when investors were anticipating a twin boost from legislation and higher base rates which would benefit US banks in particular. Nevertheless, flows picked up again during the summer. The money invested into Financials has far surpassed that going into Technology sector ETFs, which has also dominated the headlines and share price rises.
Which Sectors are Attractively Priced?
Although technology has consistently been one of the most popular sector ETFs, technology shares as a whole are looking vulnerable; valuations are high and many investors already hold large overweight positions. We are starting to see outflows from the sector, indicating that some investors are opting to cash out their gains now.
By contrast, consumer discretionary, being both cyclical and domestically-exposed, is well placed to benefit from a pick up in the European economy. Improved consumer spending is being supported by rising consumer confidence, real wage growth and better credit availability. This is a boost for luxury brands in particular, such as those in the Louis Vuitton and Moet Hennessy stable. What’s more, it is a high beta sector, which is beneficial if European equities rise.
Materials is also showing positive prospects as a European play. A pick up in metal prices in recent weeks has boosted performance, such as copper – driven by Chinese demand. This has been further encouraged by a possible ban on scrap imports to China. The materials sector also includes beneficiaries of a potential cyclical upturn through higher industrial production – such as infrastructure spending and house building.
What About the US Market?
Looking further afield to the US, Utilities benefited from low beta exposure heading into summer and is currently trading at a discount to the market. It is the highest yielding sector at 3.5%, and utilities companies typically maintain stable revenues throughout the economic cycle, performing well in slowdowns or volatile markets.
Globally, telecommunications is also benefiting from improving margins, benefiting from good second quarter results from the largest players. Industry consolidation, such as the talks between T-Mobile and Sprint, could bring greater price discipline, to the advantage of all market players. The sector is currently under-owned and under-valued, as well as cheap versus the market.
These trades show the universal appeal of sector rotation strategies. As we mark a decade of persistently low interest rates, sector rotation is likely to continue to appeal to investors of all sizes seeking diversified sources of return in uncertain times.
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