Jeff Tjornehoj on "Business for Breakfast" 1060 KRCN Tuesday, August 8, 2006 - Sector Funds Versus Sector ETFs

A: Certainly. An ETF is a basket of securities--usually stocks--that trades as an individual stock. ETF stands for "exchange-traded fund," and you have to buy that kind of fund through a broker. These funds have bid/ask spreads, you can short them, and they trade throughout the day. A mutual fund does not trade on an exchange, you buy it at one price (usually the end-of-day price), and it cannot be shorted. Looking at two portfolios, you often can't tell the difference except that a fund will hold some cash, while an ETF does not.

Q: And the sector part?

A: Sector refers to companies in a specific line of business. "Sector" usually refers to the highest level of business classification, like financial services. The industry level is a further refinement, so in this instance we'd go from financial services--the sector--down to the next level--the industry--refined to include only major banks or insurance companies.

Q: But do investors tend to use the word sector to describe all of those levels?

A: Yes, but if they know what they're getting into, it's not much of a problem.

Q: We've noticed a lot of announcements this year for new ETFs. Are ETF sponsors slicing and dicing the stock market too finely?

A: Yes, I definitely think so, when I read that one company is rolling out 19 ETFs for the medical field alone, including an ophthalmology ETF, one for infectious diseases, and another geared to companies engaged in central nervous system research. It's getting silly out there.

Q: But wouldn't a stock like Pfizer fit into most of these?

A: You're absolutely right. I wouldn't be surprised if these things track one another very closely.

Q: Are there any mutual funds getting this granular?

A: Not really. I think the reason we're seeing this phenomenon among ETFs is because there are lower operating and registration costs for ETFs.

Q: So, if mutual funds can't make this work, what does that suggest for these ETFs?

A: Imagine sitting down with a financial planner, and she says, "Scott, your portfolio looks great, but I think you need more wound-care stocks." I can't see that happening. Broad sectors such as energy or technology are a better way to spice up returns or reduce volatility. But many investors get along just fine without this level of granularity, since they already have many sectors and dozens of industries represented in a diversified portfolio.

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