Sometimes you are confident that an industry group is poised for a rebound, but you are not sure which stocks to buy to best take advantage of that rebound. There is always the risk that a company-specific problem will prevent a particular stock from participating as its industry group rises.
One way to avoid that risk is by buying a broad basket of stocks from across the industry, and one of the most efficient ways to do that is with an exchange-traded fund.
Slideshow:
10 winning ETFs
10 ETF laggards
An ETF, for those not in the know, is like an open-end mutual fund in that it holds a portfolio of stocks that you can buy into or sell out of at any time at the net asset value of the underlying stocks. However, ETFs offer some advantages over traditional mutual funds for certain investors.
One major difference is that an ETF can be traded throughout the day, with prices that move up and down with the underlying securities, while mutual funds are priced only once a day, at the market close. In addition, ETFs are usually more tax efficient than mutual funds.
Because ETFs are not constantly buying and selling the underlying shares, they rarely generate capital gains or losses for the ETF holders. Also, most ETFs passively invest in an index or a specified group of stocks, and so they have a very low fee structure.
Of course, there are disadvantages to ETFs that must be considered. Because it is a stock traded on an exchange, you must pay a brokerage commission every time you buy or sell an ETF. Also, thin trading volumes in some ETFs can lead to wide bid/ask spreads and increased transaction costs. As a result, investors who want to actively trade in and out of positions might be better off with a no-load mutual fund or some other vehicle.
Slideshows:
Menagerie of bearish ETFs
Top 10 commodity ETFs
In the paragraphs that follow, we look at ETFs that cover some industry groups that have been beaten up recently and where we think there is substantial rebound potential. While there are now many brands of ETFs to choose from, we have focused on the "iShares" sponsored by Barclays Global Investors.
Barclays is the largest provider in the ETF marketplace, and its ETFs are among the most actively traded. They are also well constructed to accurately mimic the performance of the underlying index or industry group.
iShares S&P GSTI Networking Index. The iShares S&P GSTI Networking Index is a good proxy for the telecom equipment industry that we've highlighted from time to time. The inclusion of Qualcomm and Research in Motion have led to better performance than a pure equipment index, but it also includes Motorola, Tellabs, JDS Uniphase, Juniper Networks, Corning and Cisco Systems among its top 10 holdings.
The telecom equipment industry suffered from an enormous overcapacity at the beginning of the decade, which led to a painful and prolonged retrenchment. But with industry capacity normalizing and demand for bandwidth inexorably rising, only the timing of the industry's rebound is in question.
Slideshows:
10 best-buy ETFs and funds for 2008
10 green stocks
iShares Dow Jones US Telecommunications. The telecommunications service providers have also been in turmoil as wireless and cable-based systems compete with the traditional telephone landline. But turmoil creates opportunity, and many of the telecom companies have very strong franchises. The iShares Telecom ETF is somewhat dominated by AT&T and Verizon Communications, with 38 per cent of the index, but it still provides sufficient diversification across the sector.
iShares S&P GSTI Semiconductor Index. The semiconductor industry is notoriously cyclical and, if anything, has become more so in recent years. It could be nearing the bottom of a major trough, as technology spending is likely to increase in the coming years. The iShares Semiconductor Index provides good coverage across both the chip makers and their suppliers, from Intel and Texas Instruments to Applied Materials and KLA-Tencor.
iShares Dow Jones US Home Construction. When we last reviewed the home construction industry in April 2007, we suggested a measure of caution and focused on financially stronger companies. Another way to reduce risk is with the iShares Dow Jones U.S. Home Construction ETF, which provides instant diversification in a group where there could be bankruptcies and consolidation. While it is difficult to predict when the homebuilding sector will bottom out, we know it isn't going away.
You don't even have to read the newspaper's business section to know about the carnage in the financial services industry these days; it is all over the front page as well as the evening TV news. But as Baron Rothschild once said, "The time to buy is when blood is running in the streets." There is plenty of blood in the streets in the financial districts now, and so the question is not when but what to buy. Not every financial institution will rebound; just ask the former shareholders of Bear Stearns. Here again, ETFs can come to the rescue.
Three that look particularly interesting are the iShares Dow Jones U.S. Financial Sector Index, which holds many of the major national banks and leading investment banks; the iShares Dow Jones US Broker-Dealers Index, which is more focused on the investment banks and brokerage houses; and the iShares Dow Jones US Regional Banks Index Fund, which, as the name suggests, gives you exposure to the smaller, more localized banks.
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