Read This Before You Trade Your Next ETF

. (All data from Yahoo! Finance.)

IXG — Top 10 Holdings are 24.44% of assets.
Top 3 Holdings:
JPMorgan Chase (JPM) — 3.66%
HSBC Holdings (HBC) — 4.05%
Wells Fargo (WFC) — 3.36%

IYF — Top 10 Holdings are 37.91% of assets.
Top 3 Holdings:
JPM — 7.9%
BAC — 7.76%
WFC — 6.92%

IYG — Top 10 Holdings are 57.68% of assets.
Top 3 Holdings:
JPM — 12.38%
BAC — 12.15%
WFC — 10.67%

XLF — Top 10 Holdings are 51.15% of assets.
Top 3 Holdings:
JPM — 9.87%
BAC — 9.47
WFC — 8.76%

VFH — Top 10 Holdings are 36.86% of assets.
Top 3 Holdings:
JPM — 8.2%
WFC — 7.26%
BAC — 5.02%

RYF — Top 10 Holdings are 17.01% of assets.
Top 3 Holdings:
SLM Corp. (SLM) — 2.15%
Morgan Stanley (MS) — 1.92%
Federated Investors (FII) — 1.78%

PRFF — Top 10 Holdings are 48.19% of assets.
Top 3 Holdings:
JPM — 11.15%
WFC — 8.59%
Berkshire Hathaway (BRK/B) — 6.34%

FXO — Top 10 Holdings are 14.51% of assets.
Top 3 Holdings:
W.R. Berkley (WRB) — 1.85%
Allied World Assurance Holdings (AWH) — 1.6%
PartnerRe Ltd. (PRE) — 1.47%

PFI — Top 10 Holdings are 25.73% of assets.
Top 3 Holdings:
Ameriprise Financial (AMP) — 3.12%
MetLife (MET) — 2.85%
Unum Group (UNM) — 2.71%

Now, all ETFs have different rules regarding re-balancing of holdings, discretion of holdings, focus, etc. — and some are more-liquid than others, both in stock and option volume.

Recent massive market capitalization changes in individual stocks have certainly made an impact of the relative weightings of holdings in this sector, as well.

But certainly, the active investor would be wise to know what they are buying when they invest or trade in one of these ETFs or the options on them. For example, the likes of IYG, XLF, and PRFF have around 50% of their holdings in their top 10 assets — meaning, they are not very diversified.

In addition, on IYG for example, around 25% of the holdings are in JPM and WFC alone (based on the data utilized above). So, the performance of that ETF will be greatly affected by just two securities.

In one way, you could say that is much more risky. But from another perspective, you could view this as getting more “bang for the buck.”

Then there are the very diversified ETFs, some of which attempt to equal-weight — such as RYF and FXO, where the top holdings comprise about 15% of assets and the top holdings are around 2% of assets. In the current market environment, we have seen many sectors move “en masse” quite a bit — more than what is normally the case. So, these ETFs may also move as a group.

Also remember that supply and demand is a big factor in ETF performance, because they trade as stocks, not on the actual value of their assets. But as the market settles down into more of a “stock-picking” environment — and if arbitrage-type discrepancies are seen in various ETFs vs. individual stocks, etc (as has been seen recently in preferred vs. common, closed-end funds, etc.) — then you may begin to see more price performance disparity in ETFs based on their holdings and diversification.

The bottom line is that, when you’re gearing up to invest in or trade an ETF or options on an ETF, you should examine the holdings, structure and goals of the ETF to see which one most matches the expectations (short or long term) you have for that sector.

Trade Well,
Andrew Hart