It's No Time to Call on Telecom ETFs

Telecom exchange-traded funds have crumbled in 2008 as nearly every holding has been mired in the red.

But with such a small number of stocks in each fund's basket, it will likely take longer for investors in these sector-specific ETFs to see a bottom.

"The reality is that the telecoms tend to trade more or less with the market and at a higher beta [volatility]," says Jason Browne, portfolio manager with DAL Investment. "When things are going up, they tend to do fairly well. When things are not going well, they tend to get beat up pretty good."

One reason for the funds' exaggerated moves is their relatively few holdings. "More than any other sector of the ETF market, these things are incredibly concentrated," says Matt Hougan, editor of ETF Watch and IndexUniverse.com. "It really pays to know what you're buying."

A rebound in telecom ETFs essentially hinges on the recovery of two stocks: AT&T (T Quote) and Verizon (VZ Quote). Every telecom-related fund invests in these two stocks and, in some cases, a large chunk of the holdings is dedicated to both companies.

For example, the iShares Dow Jones U.S. Telecom Sector Index (IYZ Quote) and the Vanguard Telecom Services (VOX Quote) ETFs have 37% and 39% of their portfolios, respectively, invested in AT&T and Verizon.

"The Telecom HOLDRs (TTH Quote) is even worse, with 81% of the fund in those two companies," says Hougan. "So regardless of whether the telecom sector recovers, what happens to these two companies could really determine what happens to your investment."