Article: Keep track of the sector switch

Different sectors tend to do well at different points in the economic cycle. Usually there is a gradual transition between the different stages in a cycle but an economic shock like Brexit can accelerate the process. Exchange-traded funds (ETFs) offer a fast and low-cost way of changing your sector exposure to fit different circumstances. In the wake of the referendum result, and to reflect the shifting backcloth, investment bank UBS has updated its views on European equities. Its conclusions are well worth a closer look. Upgrades and downgrades The bank downgrades late cycle industries like capital goods and banks from ‘overweight’ to ‘neutral’, reiterates its positive view on pharmaceuticals and upgrades utilities to ‘overweight’. Both pharma and utilities traditionally fare better in a recessionary environment. As we discussed in a recent article (see Shares, Cover 21 Jul) a number of indicators are pointing towards an economic downturn in the UK. UBS details how Brexit has affected consensus earnings forecasts for different sectors on a Pan-European and UK-only basis. The UK fares better thanks to sterling weakness and many UK sectors saw earnings upgrades as a result of sales derived outside of the country. The biggest upgrades are seen for energy and mining stocks. Its strategists write: ‘The level of political uncertainty and the slower economic growth in Europe clearly should have a strong impact on the positioning of our portfolios. Lower rates in the UK and Europe and the delay in the Fed rate-hike cycle are expected to have an impact on rate-sensitive sectors such as utilities, pharma, cap goods and financials. ‘The dampened growth in the UK and Europe is likely to impact sectors exposed to the domestic European market (e.g. financials), while the weakness in the pound and potentially in the euro could provide an earnings per share boost to exporters.’ It notes that a ‘lower for longer’ interest rate environment might drive investors into ‘defensive, bond-like’ stocks. UBS sees the utilities sector, in particular, benefiting from its status as a bond proxy thanks to reduced interest charges on its relatively high levels of debt and exposure to rising commodity prices. Low-cost sector exposure Sector-based ETFs have been around in the US for more than a decade but are a more recent development in the UK. Previously diversified exposure to a specific area of the market was possible by buying a large number of individual stocks or investing through actively managed funds. The latter tend to have higher fees than ETFs and can underperform if the relevant fund manager makes poor investment decisions. As well as offering a way of achieving sector rotation, sector-based ETFs could be a good step between buying the wider market through a FTSE 100 ETF like iShares Core FTSE 100 (ISF) and individual stock picking. You may not have the time or inclination to research individual shares but are confident enough in the prospects for a particular industry to want to gain exposure. The main drawback with sector-based ETFs is they often have fewer assets under management than their mainstream counterparts and therefore enjoy more limited liquidity. If an ETF remains sub-scale for an extended period, a provider may choose to discontinue it. This type of ETF also tends to have higher fees than regional or country-based ETFs. Data from JustETF on the best performing sector ETFs show products tracking gold miners have been particularly strong in the past month but also reveal a robust showing for utilities, telecoms and healthcare products albeit with an emerging markets spin.
  A COMPARISON OF THREE EUROPEAN HEALTH CARE SECTOR ETFS

iShares STOXX Europe 600 Health Care (EXV4) £63.45

Total expense ratio: 0.46% Fund size: £496 million Method of replication: Physical Tracks the STOXX 600 Utilities index which represents the largest European companies of the health care sector as defined by the Industry Classification Benchmark (ICB). By geography the largest contributor to the ETF’s performance is Switzerland at 38.4%, followed by the UK at 25.1% and Denmark at 13.3%. The ETF distributes income on a quarterly basis.

db X-trackers STOXX Europe 600 Health Care (XSKR) £104.87

Total expense ratio: 0.3% Fund size: £161 million Method of replication: Synthetic This product replicates the performance of the same index as the iShares product, which encompasses 40 different constituents in 11 different countries. Rather than investing in the underlying stocks directly, it uses synthetic replication to achieve the performance of the index. It is slightly cheaper than its iShares counterpart. Rather than distributing income it reinvests dividend money.

SPDR MSCI Europe Health Care (TELG) £104.30

Total expense ratio: 0.3% Fund size: £74 million Method of replication: Physical This ETF tracks the MSCI Europe Health Care index which encompasses companies classed as being in the health care sector by the Global Industry Classification Standard (GICS). Encompassing 27 large and mid-cap stocks in 15 developed market countries in Europe, nearly 80% of the fund is accounted by the pharmaceutical sub-sector with biotechnology the next biggest constituent at 8.2%.
  A COMPARISON OF THREE EUROPEAN UTILITIES SECTOR ETFS

Amundi ETF MSCI Europe Utilities (CU5) £149.25

Total expense ratio: 0.25% Fund size: £19 million Method of replication: Synthetic The ETF seeks to replicate the performance of the MSCI Europe Utilities index which comprises around 21 stocks in seven European markets. Around 43% of the ETF is invested in multi-utilities, 42% in electric utilities and the remainder in water and gas. The three biggest constituents of the portfolio in reverse order are Italy’s Enel SPA (ENEL:BIT) at 10.7%, Spain’s Iberdrola (IBE:BME) at 11.7% and FTSE 100 constituent National Grid (NG.) at 17.4%.

SPDR MSCI Europe Utilities (UTIL) £79.92

Total expense ratio: 0.3% Fund size: £12 million Method of replication: Physical Like the Amundi product this replicates the performance of the MSCI Europe Utilities index but does so through physical replication. The largest constituent of the MSCI index is valued by the market at €49.4 billion and the smallest at €2.7 billion. The UK is the largest country weighting at 34.6%, followed by Spain at 21.1%, Italy at 17.9% and France at 13.1%.

db X-trackers STOXX Europe 600 Utilities (TELG) £65.41

Total expense ratio: 0.3% Fund size: £15 million Method of replication: Synthetic Tracks the STOXX 600 Utilities index which represents the largest European companies of the utilities sectors as defined by the Industry Classification Benchmark (ICB). The basket of stocks is derived from the wider STOXX 600 which covers Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.