About Select Sector SPDRs
Whether you are a savvy individual investor, a financial planner, broker, institutional investor or pension plan sponsor, the following strategies illustrate how you can use Select Sector SPDRs to help with:
Customizing the S&P 500
Strategy 1: Maintain a Customized Portfolio of Select Sector SPDRs
Select Sector SPDRs allow you to purchase the S&P 500 Index in pieces, giving you greater flexibility to customize the S&P 500. You can purchase the nine Select Sector SPDRs in weightings consistent with the S&P 500 or use your own weightings to meet specific investment goals.
Example: Your investment objective is to have exposure to the broad market, such as the S&P 500 Index. However, you are speculating that the financial sector will provide strong performance during the next year, while the technology sector will suffer declines. You can purchase all nine Select Sector SPDRs, buying a heavier concentration of the Financial Select Sector SPDR (XLF) and fewer shares of the Technology Select Sector SPDR (XLK).
Select Sector SPDRs can help investors manage more tax-efficient investment portfolios. Before entering into any tax-related strategies, consult your tax advisor.
Strategy 1: Take Individual Stock Losses While Maintaining Exposure to the Sector
Sell individual stock positions currently trading below purchase price, realize the loss and maintain similar sector exposure by purchasing the appropriate Select Sector SPDR.
Example: You are currently long several stocks that are held by a Select Sector SPDR, all of which are trading below their original purchase prices. You can sell your loss positions, realize the losses, and buy the Select Sector SPDR which holds those stock positions to maintain exposure to those stocks and others in that sector.
Strategy 2: Take Losses in Funds Currently Held While Maintaining Exposure to the Sector
Sell an ETF, closed-end fund or mutual fund currently trading below purchase price, realize the loss and maintain similar sector exposure by purchasing the appropriate Select Sector SPDR.
Example: You are currently long a Technology Fund, which is trading below your original purchase price. You can sell your loss position, realize the loss, and buy the Technology Select Sector SPDR (XLK) to maintain similar exposure.
Strategy 3: Maintain a Customized Portfolio of Select Sector SPDRs and Rebalance at Year-End to Harvest Tax Losses
Select Sector SPDRs allow you to purchase the S&P 500 Index in pieces, giving you greater flexibility to customize a portfolio and better manage after-tax returns. Purchase all nine Select Sector SPDRs in weightings consistent with the S&P 500 or use your own weightings to meet a specific investment goal.
Example: Whether your objective is income or growth, you can sell the sectors with unrealized losses at year-end and maintain exposure to those sectors by buying similar ETFs. After waiting at least 31 days, you may rebalance the portfolio by swapping back into the appropriate Select Sector SPDRs with weightings appropriate to your investment objectives.
Strategy 1: Use the Flexibility of Select Sector SPDRs to Offset Long Positions
Sell short one of the Select Sector SPDRs that corresponds to your individual stock positions and reduce the downside risk without realizing a taxable event on your long positions in those stocks.
Example: You hold sizable positions of stock A and stock B with unrealized gains. To hedge the downside risk without recognizing a taxable event, you sell short the Select Sector SPDR that includes these companies.
Strategy 2: Use options as a hedge to offset downside risk in your portfolio
Options are available on all nine Select Sector SPDRs. This feature provides investors with an additional tool to manage the risk in their portfolio. Options can be utilized to minimize the downside and upside risk of both short and long stock positions.
Example: You have an extensive stock portfolio that is diversified among companies in the manufacturing, financial services, technology, and consumer staples industries. Although you’re bullish in the long term, you are concerned about short-term losses, especially in the technology sector. In addition, there is a high correlation between the performance of the technology stocks and the performance of the Technology Select Sector SPDR (XLK).
To minimize the downside risk of your technology stocks, you buy a put on the XLK. In the event that the XLK drops in price, you can exercise a put option to offset some of the losses in your stock portfolio.
Asset Allocation Strategies
Strategy 1: Diversify an Existing Portfolio with Select Sector SPDRs
In reviewing your portfolio, you realize that you are overexposed to certain sectors and underexposed to others. Use Select Sector SPDRs to over-weight underrepresented sectors and reduce exposure to sectors that overlap.
Example: Although you have investments in individual stocks, index funds and actively managed mutual funds, many individual stocks are also owned in large percentages by both the index funds and active mutual funds. As a result, this particular stock portfolio is heavily weighted with large cap names in the financial, technology, and health care sectors. However, as of the end of 2002, these three sectors also comprised 54% of the S&P 500 Index.
To correct the imbalance in the portfolio, you replace a portion of the technology, health care and financial stocks with investments in the Materials (XLB), Industrial (XLI) and Consumer Discretionary (XLY) Select Sector SPDRs. These sectors are under-weighted in both the mutual fund and index portfolios, and will help offset the technology, health care and financial sectors, which are still well represented in your other investments.
Strategy 2: Don't Put All of Your Eggs in One Basket: Use Select Sector SPDRs to Rebalance
As a prudent investor, you must make periodic appraisals of your portfolio. As market conditions change, investment positions may need to be adjusted in order for you to remain consistent with the investment objectives.
Example: A market rally in one sector can leave you exposed to a crash in the next business cycle. We all remember the tech bubble that burst in 2000. The following table shows the percentage of the S&P 500 in the technology sector at various stages in the last three years.
|Sector||Date||Percentage of S&P 500 (by market cap)|
Investors who bought the S&P 500 Index in 1998 were only counting on roughly a 10% exposure to technology. However, by March of 2000, technology stocks accounted for almost 40% of the market capitalization of the Index. By the end of 2002, the technology portion of the S&P 500 had lost more than half of its value from a high in March 2000. Select Sector SPDRs can be used as a rebalancing tool to ensure that you’re not overly exposed to any individual sector.
Strategy 3: Invest in a Sector, Not in an individual Security
Select Sector SPDRs allow you to place diversified investments in certain sectors or industry groups. This minimizes the impact of company-specific risk within an investment portfolio.
Example: You feel bullish about energy and want to allocate a small portion of your portfolio in top energy stocks. To avoid the volatility associated with investing in one or two stocks, while maintaining concentrated exposure to an industry group, you buy the Energy Select Sector SPDR (XLE), which currently provides exposure to a wide range of energy stocks.
Transition Management Strategies
Strategy 1: Use Select Sector SPDRs to Equitize Cash in a Portfolio
Whether it is an index, individual portfolio, hedge fund, or actively managed fund, extra cash can drag the performance of a portfolio that is designed to be fully invested. Select Sector SPDRs combine equity exposure needed to remain fully invested with the flexibility required for cash management needs.
Example: Your high-tech portfolio is designed to be fully invested. You allocate a certain percentage of the portfolio for short-term cash needs and purchase the Technology Select Sector SPDR (XLK). As cash needs dictate, you buy and sell the XLK, satisfying your obligations while remaining fully invested.
Strategy 2: Use Select Sector SPDRs to Handle Portfolio Manager Transition
Select Sector SPDRs can be utilized as a transition vehicle while replacing a portfolio manager or an asset class.
Example: You manage an account and are in the process of replacing a money manager. Faced with the options of keeping the old manager's portfolio or liquidating it for cash, Select Sector SPDRs provide an attractive alternative. By replacing the securities in the portfolio with Select Sector SPDRs, equity exposure is maintained until the manager is changed.
Consult your tax advisor for additional information.