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Know Your ETF's Holdings
By Price Headley | Published  03/25/2009 | Stocks | Unrated
Know Your ETF's Holdings

Exchange Traded Funds (ETFs) and options on ETFs have exploded in popularity in recent years. They offer securities that trade like stocks but are micro-focused in almost every sector in the markets (including international, commodity, short, ultra short, etc.). But there can be a great difference in the holdings, diversification and trade strategy of ETFs, even within one particular sector.

For example, let's take a look at ETFs in the Financial Sector. There are many ETFs that track this group, not even including the short and ultra short ones. Among the group of Financial ETFs include iShares S&P Global Financials (IXG), iShares Dow Jones U.S. Financial (IYF), iShares Dow Jones U.S. Financial Services (IYG), Financial Select Sector SPDR (XLF), Vanguard Financials (VFH), Rydex S&P Equal Weight Financials (RYF), PowerShares FTSE Rafi Financials (PRFF), First Trust Financials AlphaDEX (FXO), and PowerShares Dynamic Financials (PFI).

This list does not even include International, Bank, Insurance, Preferred, Short, Ultra and other types of Financial related ETFs.

Let's examine the diversification and top holdings of the above mentioned ETFs (all data from Yahoo Finance).

IXG - Top 10 Holdings are 24.44% of assets.
Top 3 Holdings:
JPM - 4.3%
HSBC - 4.25%
WFC - 2.58%

IYF - Top 10 Holdings are 37.91% of assets.
Top 3 Holdings:
JPM - 10%
WFC - 5.58%
GS - 4.28%

IYG - Top 10 Holdings are 57.68% of assets.
Top 3 Holdings:
JPM - 15.7%
WFC - 8.76%
GS - 6.72%

XLF - Top 10 Holdings are 51.15% of assets.
Top 3 Holdings:
JPM - 12.34%
WFC - 10.34%
BAC - 5.45%

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 - 2.15%
MS - 1.92%
FII - 1.78%

PRFF - Top 10 Holdings are 48.19% of assets.
Top 3 Holdings:
JPM - 11.15%
WFC - 8.59%
BRK/B - 6.34%

FXO- Top 10 Holdings are 14.51% of assets.
Top 3 Holdings:
WRB - 1.85%
AWH - 1.6%
PRE - 1.47%

PFI - Top 10 Holdings are 25.73% of assets.
Top 3 Holdings:
AMP - 3.12%
MET - 2.85%
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 2 securities. In one way you could say that is much more risky, but from another perspective you could view that 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 -- and also remember that supply & 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 one is looking at investing in or trading 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.

Price Headley is the founder and chief analyst of BigTrends.com.