Exchange Traded Funds a diversified approach to sector investing

Have you ever wondered how to establish a position in a sector of the market and not be dependent on only one or two companies performance? The most efficient way I have found is to utilize Exchange Traded Funds (ETFs). The diversified holdings in the units reduce the risk of being in the wrong company at the wrong time, but offer the growth potential of the sector overall. For a long term investor they offer an attractive alternative to mutual funds. ETFs are available on most of the major indices in the TSX and can be traded like a single stock where buy and sell levels can be determined and option strategies can also be implemented to reduce risk and increase cash flow. The ETFs trading on the TSX are liquid, the flagship S&P/TSX 60 Index Fund (XIU) for example has almost 98 million units outstanding.

The Exchange Traded Funds available in Canada are called iunits and are managed by Barclays Global Investors. The units have the management expense ratio capped at 55 basis points. Most are market weighted and have a maximum weighting of 25% for any single company. The units are deliverable and this reduces the potential for a discount or premium to the market value to develop.

There are three iunits that I believe are appropriate to consider at this time.

The S&P/TSX Capped Energy Index Fund, iEnergy (XEG), The S&P/TSX Capped Financials Index, iFin (XFN) and the S&P/TSX Capped Gold Index Fund, iGold (XGD).

All three trade on the TSX and have options available on the Montreal Exchange.

The iEnergy Index Fund (XEG) unit covers the entire spectrum of energy companies. It holds 29 energy and related companies with representation from integrated oil & gas, producers, drillers, service and pipe line companies. The top five holdings in the unit are Encana Corporation, Petro-Canada, Suncor Energy, TransCanada Corp and Tailsman Energy all of which are leaders in their industry. If the price of crude oil and natural gas continue to stay at historically high levels this sector should be one of the best performing in the Canadian market. The global demand for petroleum products is coming into a seasonally high period which should create demand for production and distribution companies as the realization that profits in this sector will be much higher than anticipated. Most analysts have been using $30.00 per barrel as an average price for 2004 which is much lower than the actual prices so far this year which means their earnings estimates will be low and any surprises will be to the upside. Buy with an initial target of $51.00, stop on close only of $38.50.

The iFin Index Fund (XFN) unit covers the entire Canadian financial services sector. The unit holds 25 companies including Banks, Insurance, Mutual Fund and Money Management firms. The top five holdings in the fund are Manulife Financial Corp., Royal Bank, Bank of Nova Scotia, TD Bank and Bank of Montreal. If the economy in Canada continues to grow along with improving loan loss experience this sector will be very profitable over the next few quarters. The steeply sloped yield curve is helping to maintain excellent spreads in the lending business. The increased interest in equity investing has increased assets under management for the Mutual Fund and Money management businesses which increases their profitability. There will at some point in the future be more consolidation in the financial services sector and by owning a diversified unit covering the entire sector you will be positioned to see the benefits of this consolidation over the longer term. Buy with an initial target price of $42.00, stop on close only $32.50.

The iGold Index Fund (XGD) covers the Canadian Precious metals sector. The unit holds 19 precious metals companies, the top five holdings are, Barrick Gold, Placer Dome, Goldcorp, Glamis Gold and Kinross Gold. The unit is dominated by Barrick Gold and Placer Dome which combined equal a 47.50% weighting in the unit. The unit includes other producers as well as across section of exploration companies. The potential for gold over the longer term is attractive as the World is becoming more and more concerned about inflation and gold has been a traditional hedge again the purchasing power erosion of inflation. Another increase in demand is coming from the Asian countries of China and India where gold has historically been used as investment when the population generally does not trust paper currencies. The global uncertainty of terrorism will tend to be supportive of the gold price. Finally gold should be looked at as a hedge against any dramatic US dollar weakness that may develop coming up to the US election this fall. Buy with an initial target of $62.00 stop on close $44.00.

The opportunity presented by Exchange Traded Funds to participate in specific sectors that appear attractive should not be over looked by investors who are not familiar with the individual companies in the sector but wish to be involved.