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Blending ETFs, Stocks at the Sector Level

The iShares S&P Global Materials Sector Index Fund (MXI) is obviously global, has 50% in metals and mining and only 40% in chemicals. Over the last few years the boom was in mining stocks, not chemical stocks, and so going into the May 2008 peak for the sector the trailing 12-month return for MXI was 32% vs. just 15% for XLB.

However, while the boom times were been better for the mining-centric MXI, the last 12 months were not so kind as MXI has lagged badly going down 14% compared to just 6% for XLB.

For one final example, let's look at the allocation our firm has for client accounts in the industrial sector. We use a very similar approach as Kotok and Cumberland but include individual stocks. For ETFs in the sector we use the PowerShares Water Portfolio (PHO), which is 58% industrial stocks and has a much smaller market cap than the sector benchmark Industrial Sector SPDR (XLI).

The other ETF we use is the iShares S&P Emerging Markets Infrastructure Index Fund (EMIF) and although only 32% in industrials we believe the composition of the fund makes it a fit for this sector. It has a trailing yield of 3%. We combine those funds with individual stocks Volvo (VOLVY), ABB (ABB) and Northrup Grumman.

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While our mix could fare poorly depending on what the market has in store, it obviously captures plenty of foreign and thematic segments within the sector and a dividend yield that is quite a bit higher than XLI.
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