Wall Street may be going all-in on futuristic technologies like artificial intelligence (AI) in 2024, but one old-economy sector is actually flourishing in the world of ETFs: industrials.
More on that shortly. But first, let’s look at what exactly are sector ETFs.
Sector ETFs 101
A sector exchange-traded fund (ETF) is an investment vehicle that invests into a specific industry, such as technology. Sector ETFs contain a basket of stocks in a particular industry, giving investors broad exposure to a sector without having to purchase large numbers of individual stocks.
The Global Industry Classification Standard (GICS) is the primary financial industry standard for defining sectors. GICS was developed by the index providers, MSCI and S&P. It has defined 11 sectors, which are further broken down into 25 industry groups, 74 industries, and 163 sub-industries.
When I was an advisor, I found that sector investing can be a powerful portfolio construction tool.
Since economic variables and business cycles impact segments of the economy differently, sector-based investment strategies can help investors align and adjust their portfolios to their very specific investing goals.
These ETFs do this in a few ways.
Sector ETFs can help capture secular trends based on macroeconomic factors (interest rates, inflation, commodities prices, and the dollar).
For example, the oil & gas industry as well as the metals & mining industry are positively correlated to inflation expectations, as higher commodity prices tend to lift inflation expectations and increase the sectors’ profits. So investors with high conviction about the direction of commodity prices or inflation expectations can use sector-based ETFs focused on these industries to adjust their portfolios.
Sector ETFs can also be used to capture long-term growth opportunities created by secular shifts or technological trends. One example was the internet. Between 1994 and 2002, the share of the U.S. population accessing the internet soared from less than 5% to nearly 60%. That led to the internet services & infrastructure industry outperforming the broad market and the overall technology sector over the past three decades.
Of course, another major benefit of sector ETFs is easy diversification.
Stock picking isn't easy. An investor may get the sector call right, but the stock call wrong.
Data from FactSet shows that over the past 21 years (through 2023), more stocks - 34% - have underperformed their respective sector averages by more than 10% than the percentage that have outperformed - 29% - by more than 10%.
Now, let’s get back to the current environment surrounding sector ETFs.
Industrial ETFs
I’m sure Wall Street was surprised when it saw that the Global X US Infrastructure Development ETF (PAVE) dethroned Cathie Wood’s flagship ARK Innovation ETF (ARKK) — the poster child for the innovation-based investment thesis — as the biggest thematic fund.
The US infrastructure ETF from Global X has about $7.5 billion in assets after adding nearly $1.5 billion this year, according to data compiled by Bloomberg. ARKK, thanks to big outflows every quarter so far this year, now holds about $5.2 billion in assets. It had started the year with nearly $9 billion.
ARKK losing assets may not be a shock; the fund has famously missed out on huge winners like Nvidia (NVDA). But PAVE climbing to the top has to be shocking to Wall Street.
Why the massive inflows into PAVE?
It makes sense. Investors are seeing that the federal government is embarking on a long-term project to boost U.S. self-sufficiency, no matter who wins the election. It’s a safer growth story than many technology stocks.
There is also the fight against climate change, and U.S. businesses looking to beef up domestic supply chains after the pandemic fallout and rising trade tensions with China and others. Add in the geopolitical pressures in the Middle East and Ukraine, combined with growing demand for new energy infrastructure in the U.S. (especially the electric grid), and the domestic industrial sector as a whole is enjoying a renaissance.
The dismal performance from tech-focused thematic funds, such as ARKK, has pushed investors toward industrial-focused ETFs. Infrastructure and industrial sector ETFs will have a longer shelf life as an investment theme. And with the industrial sector being so diverse, investors can also hone in on more concentrated plays, such as infrastructure or reshoring.
Among the thematic ETFs tracked by Bloomberg, the aforementioned PAVE has seen the biggest inflows this year, raking in roughly $1.5 billion. In the second spot is the First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID). It’s taken in $667 million in 2024.
If I were still advising clients, I would steer them toward industrial ETFs (as well as utilities ETFs) for 10% or so of their portfolio. My two favorite ETFs in the industrial sector are the First Trust RBA American Industrial Renaissance ETF (AIRR) and the Tema American Reshoring ETF (RSHO).
Most industrial ETFs offer a multi-year growth story for those investors afraid that AI-related tech stocks have run too far, too fast. They’re well worth considering to be part of your long-term portfolio.
On the date of publication, Tony Daltorio did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
