As you might have heard, there are sector changes coming where some discretionary names and some tech names will be moving from those sectors into the revamped Communication Services Sector. This impacts a lot of sector funds and could require portfolio changes depending on how things shake out. My plan is to wait until all the changes are in place (the fund I have for telecom is making its changes in stages) and then if portfolio changes are needed, try to do so in the most tax efficient manner possible.
The process needed here is a topic that is worth revisiting; looking through to an ETF's holdings to decide whether a given fund appears to be a better or inferior proxy for the exposure sought. For this post I want to stick with telecom because I use an ETF for this sector and I have an article from 2005 that allows for looking at the front end of this process and the middle (not the end, because I am pretty sure that after the sector shake up I will still use an ETF as a proxy).
Back in 2005 I wrote an article about telecom ETFs for theStreet.com where I compared and contrasted the two biggest domestic telecom sector ETFs, iShares US Telecommunication ETF (IYZ) and Vanguard Communications Services ETF (VOX) as well as how to blend other exchange traded product for foreign, telecom exposure. Between IYZ and VOX I disclosed having chosen VOX all those years ago because "for domestic telecom exposure, VOX looks to be the best choice. Its portfolio is the most diversified, with 64% of the fund in its top 10 holdings, compared with almost 80% for IYZ. One of the primary benefits of ETFs is that they avoid risks related to the performance of individual stocks. An ETF with too much concentration in the top 10 holdings can lead to more volatility."
This was an active decision and so any active decision has the chance to be right or wrong. This one turned out to be right but I would never discount the role luck plays in such a thing.
For funds that simply track an index like both of these do, looking through at things like concentration is easy to do and it is easy to see what the differences are. Often, these types of funds can have very large weightings in one or two stocks and that might require a little more work. The way I have phrased this before is that if a fund has a 20% weighting in one stock, you should probably know something about that stock and at the very least, be neutral on the name.
Aside from understanding what is in the index that underlies the sector fund you're considering, you also need to understand whether or not that sector fund overlaps with any other holdings you have whether that means other ETFs or individual stocks. Click through to this link from ETF.com to see all the funds that own Facebook (FB). It would be easy to end up very overweight the stock. Being very overweight doesn't have to be bad, it could be an active decision, but not knowing you're overweight is totally unnecessary.
Back to what to do with the current sector shake up. Again, I am not making changes yet, I need to see how all the funds I use are impacted but there is visibility for some challenges. The Discretionary sector is going to be impacted. I bought the Consumer Discretionary Sector SPDR in the teens almost ten years ago and it is at $112 now. Clients have owned iShares US Technology (IYW) longer than that and of course it is also impacted by the sector changes. The task will be maintaining the exposures while hopefully minimizing any tax consequence. If I am lucky, between the three ETF providers (SPDRs, iShares and Vanguard) all the bases will be covered without needing to sell anything, maybe I can just add to VOX because that fund has a small portfolio weight due to the old telecom sector having a small index weight.
It is important to understand that using sector funds does provide utility to diversified portfolios but not at the expense of doing work.