Know What You Own
Recently, ETFs with more exposure to SMIDs and less to Large and Mega-Caps, have benefited from rotation down the cap-scale.
The divergence between Small and Large-Cap Tech that began toward the end of last year, for instance, has been breathtaking.
The Small-Cap Tech ETF $PSCT actually outperformed its Large-Cap Sector SPDR peers $XLK by as much as 30% in a period of less than 3-months starting back in November.
The point I'm trying to make is that placing a bullish bet on Tech isn't as simple as it sounds.
You need to take the extra step and consider things including, but not limited to, the following:
- Do I want to invest in Small or Large-Caps?
- How about Equal or Cap Weight?
- Should I stick with the US or invest Internationally?
We can use cross-asset ratios like the one above to identify which areas are outperforming or showing strength and help us answer these questions.
Let's move on and say we're buying Financials now.
Are we looking to own Cap-Weight Financials $XLF, which is still stubbornly below the GFC highs, or Equal-Weight Financials $RYF which is 40% above the '07 highs? Just take a look at the ratio between the two and ask which one you'd be betting on.
Equal-weight is breaking out of a massive continuation pattern to new all-time relative highs vs XLF... which makes sense, considering the primary trend is higher.
When we look inside, the Large-Cap ETF is dominated by its whopping 40% weighting to the big banks, while the other has only 30% in banks, and double the exposure to Insurance.
How about the iShares Financials Index $IYF versus the SPDR Financials ETF $XLF?
Unlike the prior example, these are both Market Cap-Weighted, US Large-Cap ETFs for the Financial sector.
So, they can't really be too different, right?
Well, when you're talking about being either above or below the pre-Financial Crisis highs, that actually makes all the difference.
IYF is above that critical level while XLF is currently testing it from below for the 3rd time since 2018. On that note, whatever price does from here will be a major development for markets and is something we're keeping an extra close eye on these days.
So what is it that IYF has (or doesn't) that XLF is missing?
When looking into the holdings of each, it really boils down to two things:
- The LACK OF exposure to the major money-center banks (XLF's 40% vs IYF's just 25%)
- More exposure to Credit Services, which has been one of the Sector's only long-term leadership Industry's
This fits into our theme of the Tech in each area being where the outperformance lies.
Well, we can consider companies like Mastercard and Visa some of the more mature companies in Fintech - both of which carry a heavy weighting in IYF.
On the other hand, get this - XLF does not own ANY Visa or Mastercard (due to their S&P/GICS classification as Tech Stocks).
Check out this post from Strazza on the same topic from back in his Chart Report days.
Here's what he had to say about it back in 2019:
IYF has a combined 10% exposure to two of the top-performing Large Cap Financial stocks over the past decade, Visa ($V) and Mastercard ($MA), while XLF has no exposure to these companies because they are classified in the Technology sector. Visa is up roughly 1,275% since its IPO just over a decade ago while Mastercard is up a cool 6,325% since its 2006 debut.
The bottom line is we have two ETFs tracking the same thing, yet producing widely different results...
In case we haven't got the message through, let's keep going.
Here's the Equal-Weight Aerospace & Defense Index $XAR versus its Cap-Weight alternative $ITA.
When we see such dispersions between cap structures, it's usually caused by leaders or laggards under the surface of the cap-weighted ETFs that aren't being reflected in their equal-weight counterparts.
In this case, you have Boeing $BA and Raytheon $RTX, which consist of 36% of the ITA, weighing the index down. So while ITA is still 19% below the Q1 highs, XAR just printed another all-time high yesterday.
You may want to shade your eyes before looking at this next chart.
After briefly gaining 20% exposure in the supposedly "Equal-Weight" Retail ETF $XRT, Gamestop exacerbated this major disparity between the two ETFs.
So what's the lesson?
As the title says... Always know what you're buying. Know what you own. And know why you own it.
The slightest differences and nuances in the construction of ETFs which seem to track the same thing can generate materially different results.
Always be aware of this and make sure you own the best option for your investing goals and preferences.
As for us, we'll continue to focus on highlighting where the strength is among these various investment vehicles.
If you have any more examples, fire them over to me. I'd love to see them!
Louis