Sector ETFs: What They Are + How to Invest in Them

Today’s investment sector offers investors a range of instruments, each with its own risks and rewards. Among them, exchange traded funds (ETFs) have emerged as a popular choice for both institutional and individual investors.

ETFs are funds that hold securities—such as stocks, bonds, or commodities—and trade on stock market exchanges like individual stocks. An ETF’s value fluctuates based on the performance of the underlying assets. 

ETFs often track a market index, providing access to a diversified range of securities with a single purchase. They typically offer lower expense ratios than traditional investment funds, including mutual funds. Sector funds, or sector ETFs, allow investors to target segments of the economy. 

What is a sector ETF? 

Sector ETFs track a specific sector, such as biotechnology, energy, or health care, by holding securities from that industry. With a sector ETF, investors can capitalize on anticipated growth or trends in a sector while minimizing the risk associated with individual stocks.

Investing in a sector ETF means buying a piece of multiple companies within that sector. Most ETFs perform the following functions:

• Replicate the performance of a specific sector index. For example, if the technology sector performs well, a technology ETF should, too.

• Trade like an individual stock on major stock exchanges. This makes ETFs relatively liquid, allowing investors to buy or sell them during trading hours.

• Ensure transparency, allowing investors to view the specific assets held within the ETF. This provides clarity on where the money is invested.

• Pay dividends. If the companies within the sector ETF issue dividends, those dividends are typically passed on to ETF holders.

SPDR Sector ETFs

SPDR sector ETFs divide the market into sector index funds based on the Global Industry Classification Standard (GICS). This system categorizes the equities market into 11 distinct sectors.

Investment funds report on their percentage of holdings in the various sectors. The 11 GICS categories and their category codes include the following: 

• Communication services (XLC) 

• Consumer discretionary (XLY)

• Consumer staples (XLP)

• Energy (XLE)

• Financials (XLF)

• Health care (XLV) 

• Industrials (XLI)

• Materials (XLB)

• Real estate (XLRE) 

• Technology (XLK)

• Utilities (XLU)

SPDR ETFs are commonly called “spiders.” They were initially introduced by State Street Asset Managers, and the name “SPDR” stood for "Standard & Poor's Depositary Receipts." However, SPDR ETFs have expanded to include a wide range of ETFs tracking various indices beyond those related to Standard & Poor's (S&P). 

What are the common types of sector ETFs? 

Modern sector ETFs cover nearly every segment of the economy. Here are some examples:

Health care

These ETFs include pharmaceutical firms, biotechnology companies, and health care service providers. Notable examples include Johnson & Johnson (NYSE: JNJ), Pfizer (NYSE: PFE), and Merck (NYSE: MRK). 

Technology

Tech sector ETFs hold securities from across the technology industry, including hardware, software, and internet or communications services providers. Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), and Google’s parent, Alphabet (NASDAQ: GOOGL), are typical holdings. 

Real estate

Real estate ETFs invest in commercial and residential property owners, land companies, developers, and builders. Real estate investment trust (REIT) ETFs fall into this category. 

Energy

These ETFs invest in the entire spectrum of energy companies, including traditional oil and gas companies, like ExxonMobil (NYSE: XOM) or Chevron (NYSE: CVX), as well as green energy firms like NextEra (NYSE: NEE) and TPI Composites (NASDAQ: TPIC).   

Consumer staples

The companies included in these ETFs produce essential goods that consumers typically don’t cut back on, even in challenging economic times. The list consists of companies like Procter & Gamble (NYSE: PG), Colgate-Palmolive (NYSE: CL), and Coca-Cola (NYSE: KO). 

Pros of sector ETFs

Like all investments, sector ETFs have upsides and downsides. Here are some advantages to choosing these investment funds:

Focused exposure 

Sector ETFs’ primary benefit lies in their focus on a particular industry. An investor who believes in innovative breakthroughs may be bullish on the tech sector. In contrast, one who has studied the statistics on aging populations may think the health care sector will boom. Whatever their predictions, they can capitalize on those economic trends via sector ETFs. 

Diversification 

A sector ETF distributes risk by broadening exposure to multiple companies. You’re not betting on a single stock; you’re investing in a basket of assets. Diversification helps shield your portfolio from company-specific setbacks and reduces overall volatility. 

Liquidity

Sector ETFs are traded on major stock exchanges just like individual stocks, so they generally offer high liquidity. Investors can buy or sell shares whenever their strategy calls for it. 

Cons of sector ETFs

Investors should also be aware of sector ETFs’ downsides, including the following:

Concentration risk 

Sector ETFs offer diversification within a sector, but they concentrate exposure on the ups and downs of that industry. If the entire industry struggles, the ETF’s value can decline significantly. 

Limited industry diversification 

By investing primarily in a single industry, you may miss out on growth in other booming sectors. 

Marketing timing 

Achieving success with a sector ETF often hinges on correctly predicting industry trends. Market timing is tricky even for seasoned investors.

Meet Composer: No coding skills required 

Are you closely monitoring an economic trend in a specific sector? Do you think the market will respond positively? A sector ETF might be the instrument you're seeking.

Composer’s easy-to-use, automated platform offers a range of tools, including an extensive ETF database, giving access to sector ETFs. Our platform provides you the tools to take control of your investment journey and turn your financial acumen into a robust portfolio.  

Composer empowers you to build effective algorithmic trading systems, dynamic strategies we call symphonies. The best part? No coding skills are required. Composer’s ChatGPT-4-powered allows you to describe your goals in simple, everyday language, and our AI platform will automatically construct your symphony.

Alternatively, you can start with a portfolio from Composer’s deep library of pre-programmed strategies. 

How to invest in sector ETFs with Composer 

Follow these three simple steps to turn your market insight into a portfolio with sector ETFs. 

1. Sign up for Composer for free 

Start by taking advantage of Composer’s 14-day free trial. Go to Composer’s sign-up page and create an account by answering a few simple questions and adding funds. Once funded, you can invest in a pre-made symphony or create your own. 

2. Create a new symphony

Once funded, you’re one step closer to building your portfolio. 

Go to the “Create” button on the top left corner, then select “+ New Symphony.” This is where Composer’s AI tech turns your market insights into something real. 

• Click “Create with AI” to open a chat with the AI tool

• Type in your investment priorities. The ChatGPT-4-powered system allows you to ask in plain language. 

For example, you might say, “Invest in a basket of sector ETFs focused on health care, defense, and energy.” Our system will produce a symphony incorporating each of the sector ETFs. From here, you can tweak assets and balances in our intuitive, no-code editor. 

3. Selecting sector ETFs

Using backtesting tools, the Composer helps you select the best sector ETFs for your objectives. Consider these unique options:

• A stock ETF seeking to outperform the S&P 500 through dynamic sector rotation, choosing sectors undervalued and poised to respond favorably to financial market catalysts 

• A bond ETF tracking an index of the consumer non-cyclicals sector—companies whose performance is less connected to the business cycle 

• An iShares fund, a diversified stock ETF based on an underlying index of computer and device producers, internet service providers, and software companies 

Join Composer today to build a portfolio, execute your strategy, automate your trades, and rebalance your holdings.