Technology companies have always been classified as growth machines, aggressively reinvesting profits and thereby sowing the seeds of innovation and future profit growth. However, individual investments in tech stocks can be a polarizing subject amongst individual investors. This is primarily due to factors surrounding the competitive nature of management, culture and corporate governance. For these reasons, owning a basket of tech stocks in the form of an Exchange-Traded Fund (ETF) may be a better strategy for some people than individual stock selection. ETFs take nearly all of the individual fundamental attributes of stocks out of the equation, allowing investors to focus on select areas of the technology ecosystem.
The opportunities in technology and the sheer number of options available for ETF investors have never been more abundant. When allocating to a technology-focused ETF, key considerations should include (1) index selection (2) fund size and (3) strategy. Striking together an intuitive balance of funds with growth or income potential could add a supplementary facet to an otherwise traditional portfolio management approach.
Shopping for an ETF by trying to compare and contrast performance and individual fund characteristics is often times an arduous task. However, it doesn’t need to be when you consider that nearly all of the details on security selection are spelled out in plain black and white. You simply need to formulate what your portfolio goals are and how you can integrate an appropriate technology ETF into your portfolio to align with those goals.
Now that ETFs are considered a mainstay investment option for short and long term investors alike, sector ETFs encompassing every form of broad-based and industry-group specific strategies have amassed a bountiful landscape of imaginative and useful products.
One of the oldest solid-state products in existence that still contends popularity is the Technology Select Sector SPDR ETF (XLK). As the second largest technology ETF by assets under management, it was originally designed alongside it peers, the Select Sector SPDRS, to be part of the 10 individual sectors of the S&P 500 Index. XLK is market cap weighted, and envelopes the cross section of technology stocks strictly within the S&P 500. For this very reason, it carries a large concentration of large-cap stalwart tech names such as Apple AAPL +0.26% Inc. (AAPL), Google GOOG +1.15% Inc. (GOOG) and Microsoft MSFT -0.29%, Inc. (MSFT).
XLK offers investors an easy avenue of overweighting technology within a diversified portfolio of broad-based market indexes. However, it’s important to consider XLK’s lack of diversification outside tech names not admitted to the S&P 500. Which in turn leaves aside small- and mid-cap names in favor of large, well established companies with long operating histories.
Created through a collaboration of traditional index formulation and fundamental characteristic research, the First Trust Technology Alphadex Fund (FXL) is an ETF which ranks and then overweights companies with strong fundamental attributes. These traits include six and 12 month price appreciation, return on assets, book value to price and cash flow to price ratios. In the end, the top 75% of the screen marks 90 stocks for inclusion to the index ranging from small to large capitalization companies.
Investors seeking niche exposure in the world of technology stocks now have the option of investing in ETFs that target specific sub-sectors of technology. These products were created specifically for tactical investors that prefer a layer of diversification, but not at the expense of including an underperforming industry group within a specific sector.
Two examples of these ETFs are the First Trust Dow Jones Internet Index (FDN) and the PowerShares NASDAQ Internet Portfolio (PNQI). These ETFs are designed to track the largest, most liquid companies that generate at least half of their revenue from an internet related business. FDN’s top holdings include Facebook Inc. (FB), Amazon Inc. (AMZN) and eBay, Inc. (EBAY), while PQNI’s top holdings are also Facebook (FB) and eBay, Inc. (EBAY), as well as Google Inc. (GOOG). An aggressive investor might favor a position in FDN to hone in on the rapidly expanding growth of internet stocks engaged in content distribution or social networking versus companies engaged in the manufacturing and sales of technology hardware or software. Since FDN and PQNI are specialized strategies, it’s no surprise that their expense ratios are 0.60%, which is significantly higher than most broad-based ETFs.
Lastly, for investors seeking income from their invested capital, there is an index strategy that can leverage the strong free cash flow and healthy balance sheet attributes of mature technology and telecommunications companies. The First Trust NASDAQ Technology Dividend ETF (TDIV) tracks a specialized index that is comprised of companies across the capitalization structure that have a consistent history of paying dividends to shareholders. TDIV carries a current SEC Yield of 2.53%, and has an expense ratio of 0.50%. An investor looking to diversify a traditional equity income portfolio outside interest rate sensitive areas such as utilities or consumer staples stocks could utilize a fund like TDIV.
As the technology landscape has evolved over time, so have the need for products targeting multiple areas of the marketplace. ETFs have proven themselves to be one of the easiest and most efficient vehicles for exposure to individual sectors and industry groups. Evaluating and selecting the appropriate ETF for your underlying goals could ultimately yield the most favorable outcome, rather than investing in individual stocks.
*All performance statistics as of 2/3/14, data provided by Morningstar.com.