3 Sector-Specific ETFs To Consider

3 Sector-Specific ETFs to Consider

There are a lot of ETFs that focus specifically on a single sector. Not a good approach for diversification, but these ETFs can often outperform the market.

Adam Othman

Adam is a value investor who is always on the hunt for fantastic undervalued companies that he can share with Motley Fool readers. He follows Warren Buffett and Charlie Munger's investment advice and has completed the Canadian Securities Course. When he's not investing, Adam can usually be found traveling or skiing.

Published January 27, 2022 3:18 pm EST

Exposure to a specific sector doesn’t make sense from a diversification perspective, but it is often a good way to beat the market. Take the 2020 crash as an example. Right after the crash, tech and gold stocks started soaring. Other sectors, like financials, took their time. The energy sector was among the last ones to experience a robust recovery-fuelled growth.

Different patterns and peak timings of different sectors could have been utilized to spread out the overall realized gains over an adequately long period. And that’s just one reason to consider sector-specific ETFs – to capture the sector-wide upside when the market conditions are right.

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An energy sector ETF

iShares S&P/TSX Capped Energy Index ETF (TSX: XEG) is Blackrock’s Canadian energy sector ETF, made up of 22 holdings. However, the ETF didn’t equally divide the weight of holdings, and at the time of writing this, the top three holdings that make up about 62% of the portfolio are Canadian Natural Resources, Suncor, and Cenovus Energy.

The distribution of holdings, the high-risk rating, and the 0.61% MER might not make it an ideal pick. But the ETF did manage to grow almost 92% in the last 12 months. This is impressive growth for a fund made up of $1.5 billion in net assets. Another interesting fact regarding the fund is its AA ESG rating from MSCI, which can actually help raise the overall ESG profile of your portfolio, something uncharacteristic for an energy-oriented asset.

A REIT-oriented ETF

Real estate is one of the most sought after investments, and if you don’t have the capital to invest in the asset directly and you are worried about the performance of individual REITs, an ETF like BMO Equal Weight REITs Index ETF (TSX: ZRE) might be the right investment for you. It follows the Solactive Equal Weight Canada REIT Index and has 23 holdings.

The weight is very evenly distributed among the holdings, so a small number doesn’t account for most of the weight. As a REIT-oriented ETF, the fund does offer a decent annualized yield of 3.94% and makes monthly distributions. But there are two other reasons to consider this ETF for your portfolio: its capital appreciation potential and the medium risk rating.

A financial sector ETF

The Canadian financial sector, thanks to the stability of its banks, is considered quite safe as a whole. And if you are getting exposure to the sector as a whole via an ETF like iShares S&P/TSX Capped Financials Index ETF, the risk gets diluted even further. Thankfully, the upside doesn’t. The ETF has risen 32% in the last 12 months, which is uncharacteristically high for it.

The long-term growth prospects are quite impressive as well if you consider the fund’s history. You would have grown your capital three times if you had invested in the fund a decade ago. Since they are heavyweights in the sector, the banks are heavily represented in the fund’s holdings, and just four banks make up about 58% of the fund’s weight.

Foolish takeaway

Before you make your choice about the ETFs, you have to take the condition of the sectors into account. The energy sector is going through a bullish phase that may have pushed it higher than its intrinsic value, or the volatility of the industry would have corrected it to if it weren’t for the demand-supply fluctuations last year. Financials and REITs, however, may have healthier long-term outlooks.