An interesting year for tech ETFs

Most large technology funds are lagging the S&P 500 year-to-date -- but not all of them. What's helping the winners?

By Benzinga Sep 4, 2013 2:13PM

On the surface, it would appear to be a disappointing year for technology ETFs. The Technology Select Sector SPDR (XLK) is up a mere 9.9% year-to-date, a performance that trails the SPDR S&P 500 (SPY) by 670 basis points.

Of the nine sector SPDRs ETFs, XLK ranks seventh on a year-to-date basis and is being kept out of the last place by the Materials Select Sector SPDR (XLB) and the Utilities Select Sector SPDR (XLU), the latter of which has wilted in the face of rising interest rates.

What is disappointing about the performance of the cap-weighted, large cap-focused XLK is that when stripping out AT&T (T) and Verizon (VZ) to focus on the pure tech names among the ETF's top-10 holdings, five of the remaining eight names have traded higher this year. In fact, XLK is not even the best U.S. technology sector ETF issued by State Street Global Advisors. That honor goes to the SPDR Morgan Stanley Technology ETF (MTK), which has returned 15.3% this year with some help from Facebook (FB) and (PCLN).

Still, it is possible to find market-beating U.S.-focused tech ETFs. Even when excluding the PowerShares S&P SmallCap Information Technology Portfolio (PSCT), which has been a stellar performer in its own right, investors could have done better with tech ETFs this year.

The right tech ETFs that is. Some of this year's top tech ETFs share an important trait in common. These funds offer investors exposure to the increasingly prominent theme of fundamental weighting methodologies.

Take the PowerShares Dynamic Technology Sector Portfolio (PTF) as one example. PTF is weighted by factors including price momentum, earnings momentum, quality, management action and value. None of the ETF's 61 holdings account for more than 2.82% of the fund's weight. Apple (AAPL) is not a member of PTF's lineup, which is a good thing given that the stock has traded lower this year.

However, PTF has gained 14.4% this year while also excluding Google (GOOG) and Microsoft (MSFT), just to name a pair of large-cap tech stocks that have performed well in 2013. (Microsoft owns and publishes MSN Money.)

Speaking of Apple, the stock's impact on various ETFs and how funds with excessive exposure are vulnerable when it falls have been well documented. Equal-weight ETFs avoid that conundrum.

The First Trust NASDAQ-100-Technology Sector Index Fund (QTEC) and the Guggenheim S&P 500 Equal Weight Technology ETF (RYT) are up an average of 20.5% this year. Both funds feature scant allocations to Apple, but the same goes for their exposure to Google. RYT actually has a slightly larger weight to Yahoo (YHOO) than it does Google. RYT is up 21.6% this year, meaning it has topped Google by 260 basis points.

The First Trust Technology AlphaDEX Fund (FXL) also eschews cap-weighting in favor of a mix of growth and value factors, including price appreciation, sales-to-price and one-year sales growth, book value to price, cash flow to price and return on assets.

Apple happens to be FXL's largest holding at 2.3% of the fund's weight. The 1.35% allocation to Google is well below the weights given to 3D Systems (DDD), Groupon (GRPN) and Yahoo, just to name a few. The result is an ETF up 19.6% this year.

Another thing these ETFs share in common is that none is particularly large, though three have over $100 million in assets under management. Combined, PTF, QTEC, RYT and FXL have about $707 million in managed assets compared to $11.3 billion for XLK.

Disclosure: The author does not own any of the securities mentioned here.

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