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What Are Industry Etfs And How Can Investors Use Them?

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The global economy is developing faster and more diverse. So-called industry ETFs also benefit from this development. With just one industry ETF purchase, investors can add the performance of an entire industry to their portfolio and thus ensure additional diversity and diversity. However, sector ETFs are also not without risk, as strong fluctuations in the economic cycle or unforeseen economic crashes can also have a targeted effect on individual sectors.

What are industry ETFs and how do they work?

As diverse as the global economy is, it can ultimately be divided into different industries (also called sectors). Regardless of whether they are in the automotive or healthcare sector, companies in the same economic sector are usually subject to the same fluctuations, e.g. B. through changes in the law, political developments or rising raw material prices. Industry ETFs build on exactly this. As with conventional ETFs , industry ETFs are exchange-traded mutual funds – with the difference that an industry ETF only records the development of securities within a specific industry. The underlying index of the industry ETFs thus reflects the performance of an industry.

Which industry ETFs are there and which are useful?

Basically, the global economy can be divided into the following large sectors :

  • Construction
  • Financial services
  • Healthcare
  • Raw materials
  • Household items
  • Industrial goods
  • media
  • Telecommunications
  • Supplier
  • Consumer goods

The various industries are only roughly summarized and also differ depending on the classification scheme of the industry ETF. For example, sector ETFs in the real estate sector are classified under the ICB classification under the financial services category, while the GICS classification defines real estate as a separate sector.

Depending on the respective business cycle, each industry shows different value developments and trends. All industries develop differently and the development of each individual industry is so dynamic and dependent on external influences that no general recommendations can be made. Which industry ETFs make sense also depends on the prior knowledge and personal motives of the investors. However, especially with industry ETFs, many investors pursue certain industries out of personal interest.

What role does industry rotation play in investing in industry ETFs?

Anyone who deals with the topic of industry ETFs will quickly come across the terms industry rotation (also known as sector rotation) and industry rotation strategy. The economic phases that the economy goes through over time are decisive for this.

The four different phases of the economic cycle are called economic phases:

  • Upswing (expansion)
  • Boom
  • Downturn ( recession )
  • Low phase (depression)

The various industries develop either rising or falling trends due to the economic phases. It is precisely this that investors take advantage of in the sector rotation by investing only temporarily in certain sectors and then reallocating their portfolio accordingly in the event of an economic downturn. If, on the other hand, an industry promises increasing performance and profits, the portfolio is adjusted accordingly.

For advantage of the industry rotation strategy, you should factor in the risk that this strategy entails. Because how individual industries will develop cannot be said with certainty. Anyone who simply invests blindly in an industry and hopes for an economic upturn may have to record high losses. The industry rotation strategy is therefore only suitable for more experienced investors who have a feel for the economic developments in the market.

What are the pros and cons of industry ETFs?

Like all ETFs, industry ETFs are also subject to normal market fluctuations and, in addition to profits, can also record heavy losses. Anyone who wants to invest in industry ETFs should know the advantages and disadvantages and the associated risk.

Benefits

  • Investments in an entire industry can be more stable than investments in a single compa 
  • Flexibility in buying and selling        
  • Lower cost compared to buying blocks of shares   

Disadvantages

  • “Cluster risk” by focusing on an entire industry
  • Investment in the entire industry and thus also in companies with falling prices
  • Rather unsuitable for beginners, as industry and financial knowledge is required

Benefits of industry ETFs

Anyone who buys an industry ETF invests in an entire industry. As a result, high losses in value of an individual company within the industry may not be so significant. Investors who, on the other hand, buy individual blocks of shares within the industry, will feel a sharp loss in value of a share in the portfolio more clearly. In addition, investors who invest in a single industry ETF are more flexible, as a single industry ETF can be bought or sold faster than several individual stocks of companies within the industry. With industry ETFs, you can track economic trends more quickly and easily than with different stocks in one industry. The costs are correspondingly lower as you invest in the stocks of an entire industry with just one purchase.

Disadvantages of industry ETFs

Industry ETFs bring with them a “cluster risk”. Anyone who relies solely on one industry also bears the risk that the entire industry will develop poorly and record losses. By investing in an entire industry, investments are also made in weak companies with falling prices. If you want to invest in industry ETFs, you should also have a basic knowledge of possible economic developments in the business cycle. Investors who invest “blindly” in an industry easily risk losses in their portfolio. It is also crucial to react quickly to negative trends in an industry and to realign the portfolio. Industry ETFs are therefore more suitable for more experienced investors.

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