Tech ETFs that put Microsoft in your porfolio

These funds will give you a stake in other great tech names as well.

By InvestorPlace Jan 31, 2012 11:43AM
 Christian Zachariasen/JupiterimagesBy Will Ashworth,

How can you tell that exchange-traded funds, despite their rise in popularity, have a long way to go to catch mutual funds? Check out the number of ETFs with Microsoft (MSFT) as a top 10 holding compared with mutual funds. According to Morningstar, 66 ETFs count the tech giant among their top holdings, compared with 2,416 mutual funds. Clearly, a lot of portfolio managers feel Microsoft is a necessary component of any portfolio.

If you're thinking about owning Microsoft stock, why not contemplate an ETF instead. You'll get a stake in Microsoft as well as some other great tech companies. (Microsoft owns and publishes Top Stocks, and MSN Money site.)

Because of the large group of ETFs from which to choose, there are several ways investors can play this. Let's start with traditional technology funds. If assets under management and size are a concern, then your first fund to consider must be the Technology Select Sector SPDR (XLK), which has $8.6 billion in total net assets and average daily volume of 12.2 million, about one-quarter the volume of Microsoft itself.

Microsoft is XLK's second-largest holding behind Apple (AAPL), with a weighting of 8.41%. It's a fairly concentrated portfolio with 78 holdings, and 65% of its assets are invested in the top 10 holdings. A play on the XLK is a bet on the tech giants. Less than 12% of the fund is invested in mid-caps or smaller.

Over the past decade through Jan. 20, the fund trailed the S&P 500 by 136 basis points annually, but it has beaten Microsoft by 123 basis points annually over the same period. At an expense ratio of 0.20%, if you like Microsoft, but want some extra tech diversification, this is a good choice.

An interesting alternative to an ETF based on a market-weighted index is to invest in a tech fund that's equally weighted instead. The Rydex S&P 500 Equal Weight Technology Fund (RYT) seeks to replicate the performance of the index of the same name. It has 71 holdings, with Microsoft's weighting a tiny 1.45%. If you must have a bigger percentage of the pie invested in Bill Gates'S baby, then this isn't for you.

However, RYT's top holding, JDS Uniphase (JDSU), has a weighting of just 1.79%. Its top 10 holdings represent just 16.2% of the fund's $106 million in total net assets. Over the past five years, the RYT has underperformed the XLK by 191 basis points annually.

Here's where it gets interesting. While the XLK is invested mostly in large caps, RYT has 53% of its assets in mid-cap stocks. Mid-caps historically outperform both large- and small-caps over longer periods. The RYT launched only a little more than five years ago. Give it another decade, and I think you'll see a different story.

Moving outside technology to large-cap and all-cap funds, we have several interesting alternatives. For investors fixated on cost, I'll make my first choice from funds with an expense ratio less than 0.25% and holding Microsoft in the top 10. The obvious choice is the PowerShares QQQ (QQQ), which tracks the 100 largest nonfinancial stocks on the NASDAQ.

Since around March 1999, QQQ now has total net assets of $29.2 billion, making it the ninth-largest ETF by assets. Microsoft is its second-largest holding, with an 8.49% weighting, and technology represents 64.3% of its overall holdings. At an expense ratio of 0.20%, if technology is your thing and not just Microsoft, this is the ETF for you.

Finally, if you're interested in an ETF that invests in large-caps such as Microsoft but also spreads its assets around, making room for small- and micro-cap stocks, the Flexshares Morningstar US Market Factor Tilt Index Fund (TILT) is a possibility. With an expense ratio of just 0.27%, its move beyond large-caps won't break the bank. Considered an all-cap fund, micro-caps and small-caps account for slightly less than 43% of its assets, mid-caps 14.7% and large-caps the remaining 42.3% of the portfolio.

When you bring everything together, its investment style ends up being a mid-cap blend of growth and value. With QQQ holding almost 2,500 stocks, Microsoft's weighting is a mere 0.93%, despite being the fourth-largest holding. That's because it takes the traditional U.S. broad market-weighted ETF and tilts the holdings toward smaller-cap and value stocks while still providing a fair representation of the total U.S. market. The fund got its start only in September 2011, so there's not much of a performance record, but it definitely has an interesting premise.

I could go on for days talking just about ETFs investing in Microsoft. For many investors, technology is a portfolio must. Hopefully, the few funds I've mentioned will give you a good head start.

And if Microsoft isn't the right tech company you'd like to have in your portfolio, try these two steady funds getting help from IBM (IBM) instead.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

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