Exchange-Traded Funds: Sector Performance and Diversification

Abstract

This article is motivated by the growth of tactical asset allocation portfolios as an active investment option that lies between a purely passive investment approach and traditional active management. The article explores the ability of sector-focused ETFs to mimic the risk and return behavior of industry subsectors. The authors use Global Industry Classification Standard (GICS) sector indexes as proxies for industry subsectors and compare the appropriate GICS sector index to sector ETFs to quantify the ETFs’ ability to mimic the risk–return relationship of the sector. The authors find that the sector-focused ETFs closely mimic the risk and return of economic sector indexes that have broad market capitalization and style exposures.