Why sector ETFs are vital in the current environment

Canada has a concentrated economy, and portfolios constructed only with domestic stocks face several roadblocks and are limited in what they can achieve. However, there are options for Canadian investors to achieve much-needed diversity. Sector ETFs, which offer targeted exposure to companies in specific segments, represent a sensible and solid option for Canadian investors to pursue growth and diversify portfolios, at a low price.

“The use of sector ETFs gives Canada-based investors the ability to compensate for Canada’s rather narrow exposures across financials, energy and materials,” says Mark Webster, BMO GAM Director, Western Canada. “They can easily mitigate this by buying sector ETFs in the areas that Canada is weak compared to other economies, in particular healthcare, technology and consumer discretionary.”

As well as providing instant and easy diversification, sector ETFs allow for a greater degree of precision in portfolio construction and enable investors to be surgical in selecting the areas of the market that best suit their investment strategies.

The US technology sector is a market that Webster encourages advisors to pay particularly close attention. “It is an area that is relatively absent in our economy, so investors should seriously consider adding something like the BMO Global Communications Index ETF (COMM) to their portfolios for some global technology exposure,” he says. “Many investors buy a Nasdaq ETF for tech exposure, but that is not a true sector ETF and is only 58% technology. COMM offers pure exposure to technology and communications.”

With the endless stream of headlines about astronomical tech gains, advisors may be tempted to select a small basket of individual tech companies for client portfolios. There are, however, several investor advantages associated with buying an ETF rather than a handful of selected shares. An ETF forces diversification across a greater number of names and trades can be executed far easier. Investors can easily apply the exposure to the portfolio and then remove it as needed.

“The benefit of BMO sector ETFs is that, in many cases, we have embraced equal weight indices or have placed cap on the weight not to exceed 10 percent. This is to avoid concentration risk,” Webster says. “If you use a market capped index you can end up with profound concentration risk around four or five names. But, if you are buying something pooled like an ETF, you are doing so because you do not have a preference for one company over another. So it makes sense to diversify broadly by using an equal weight format.”

Webster speaks to many portfolio managers who use sector ETFs to implement specific themes within client portfolios. “Some of the themes I am currently hearing about are on industrials, tech, communications, energy, metals and consumer staples,” Webster says. “I would encourage individuals interested in these themes to take a look at the BMO Global Consumer staples Hedged to CAD Index ETF (DISC), BMO S&P/TSX Equal Weight Industrials Index ETF (ZIN), BMO S&P/TSX Equal Weight Oil & Gas Index ETF (ZEO), BMO S&P/TSX Equal Weight Global Base Metals Hedged to CAD Index ETF (ZMT) and BMO Global Communication Index ETF (COMM).”

BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager and separate legal entity from Bank of Montreal.

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