ETFs Offer Four Different Ways to Index Technology

A lot of competing exchange-traded index funds are starting to hit the market, and the differences between them aren't always obvious.

If you're a technology indexer, for example, you'll soon be able to choose among ETFs tracking four different tech indexes. Which one is best for you? Good luck trying to figure that out. Given the scraps of information currently scattered across the Internet, you could spend days trying to compare one fund to another.

Barclays Global Investors just started rolling out the first of 35 exchange-traded index funds -- called iShares -- that it will launch over the next two months. State Street Global Advisors, which runs the S&P 500-tracking Spider(SPY Quote), will introduce eight new ETFs next month. Plus, you'll already find the popular Nasdaq 100 Tracking Stock(QQQ Quote) and nine Select Sector Spiders, which track the various segments of the S&P 500. Vanguard also is getting into the ETF game.

Exchange-traded funds are just different enough to confuse old-line mutual fund investors. They look similar to traditional funds but they trade like stocks. You don't actually invest money into the portfolio, but you buy shares in the secondary market from other investors and market makers.

Throw in all the new funds that are starting to appear, and you've got utter confusion. You can find basic information on these funds, like expense ratios, but other information that is easy to find for traditional funds, like median market cap, is nearly impossible to find for ETFs.

Barclays does have a Web site devoted to its new iShares, but it leaves much to be desired, says reader Arvinder Uppal. "All I want to know is the components of the different indices, but their Web site is extremely slow, and when you eventually get to the holdings, they just list the top holdings, and not the whole index," he writes. "When will they learn? Today's fast-paced investor does not want to wait for a prospectus by snail mail or go through a complicated download procedure."

Amen.

To help you sidestep this ridiculous rigmarole, I'll occasionally compare various products or indices in a particular sector or industry.

Today, technology.

The Indices

Within the next month, you'll have four technology ETFs to choose from.The Nasdaq 100 tracking stock, the Technology Select Sector Spider (XLK Quote) and the iShares Dow Jones U.S. Technology Index fund (IYW Quote) already exist. State Street will be launching the SSgA Morgan Stanley High Tech 35 Index fund around the middle of June.

They obviously aren't alike. Just look at one-year performance. Nearly 40 percentage points separate the top performer, the Morgan Stanley High Tech 35, and the laggard, the Technology Spider.

Tech Index Smogasbord Competition among ETF providers has produced a menu of choices for technology indexers.
Index	Exchange-Traded Fund	Number of Stocks	One-Year Performance
Dow Jones U.S. Technology	iShares Dow Jones U.S. Technology (IYW Quote)	315	45.2%
Morgan Stanley High Tech 35	SSgA Morgan Stanley High Tech 35*	35	63.3
Nasdaq 100	Nasdaq 100 Tracking Stock (QQQ Quote)	100	46.7
Technology Stocks in the S&P 500	Technology Select Sector Spider (XLK Quote)	94	25.2
Source: Baseline, Dow Jones, American Stock Exchange. Performance through May 23. *Expected in June.

Short-term performance doesn't tell you everything you need to know about the indices. You'll also need to know which index contains nontech stocks, which offers the most diversification among small-, mid- and large-cap stocks and which has the lowest expense ratio.

"I am not a big sector-index proponent," says Jeff Troutner, president of TAM Asset Management in San Anselmo, Calif., and senior editor of IndexFunds.com. But "I would always opt for more diversification."

The Dow Jones U.S. Tech index will give you that. The index has 315 stocks -- more than three times the number you'll find in any of the other three. The index, derived from the Dow Jones U.S. Total Market Index, has "a full representation of large-cap and mid-cap tech stocks and 50% of small-cap tech stocks," says John Prestbo, editor of the Dow Jones indices. "Below that, you have severe liquidity problems."

This index provides more exposure to smaller companies than the others. Its median-market capitalization is just $2 billion, compared with $16.2 billion for the Nasdaq 100, which represents the largest 100 nonfinancial stocks that trade on that exchange. The Tech Spider has fewer than 100 stocks and a median market cap of about $14 billion. The Morgan Stanley index holds just 35 mostly large-cap tech names that give the index a $45 billion median market cap.

The largest holdings in most of the indices are the same. The Dow Jones Tech, Nasdaq 100 and Tech Spider all have well over 20% of their assets in three familiar stocks: Microsoft(MSFT Quote), Intel (INTC Quote) and Cisco (CSCO Quote). A good part of their performance will be dominated by these three names.

That's because these indices are market-cap weighted. This structure allows the cream to rise to the top, so to speak.

The 35 stocks in the Morgan Stanley index are equal weighted, which means each one gets an allocation of about 3%. (The index rebalances every quarter to keep the hottest stocks from overpowering the index.)

This is an interesting and, when you think about it, practical approach, because that's the way the average investor would probably structure a portfolio -- by putting equal amounts of money in several stocks.

However, it also means that the index must consistently trim back the stocks that are doing well and add to the ones that aren't.

If the S&P 500 were built that way, the index would be selling Microsoft to buy more of something like Bethlehem Steel (BS Quote).

Sheets Aren't High-Tech

Speaking on old economy stocks, the Nasdaq 100 is not all tech. Yes, more than 75% of the index is in tech, but it also contains health care and biotech stocks along with retailer Bed Bath & Beyond (BBBY Quote).

Lastly, if you are considering holding one of these index funds for a while, you should look at the expenses. The Dow Jones Technology iShares are the most expensive of the existing funds. That expense ratio comes in at 0.6% annually. The Tech Spider just lowered its expenses to 0.28% a year, and the Nasdaq 100 is a bargain at 0.18%. No word yet on expenses for the SSgA Morgan Stanley tech index.

Of course, if you are going to be trading these funds and paying a commission every time you buy and sell, the expense ratio won't matter as much to you.

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