ETFs
ETFs are supposed to simplify complex ideas. Here’s what you need to know about them before you buy.
The very concept of exchange-traded funds (ETFs) is to make investing easier. With a single investment, you can buy a large number of stocks and bonds, instantly creating a diversified portfolio. But Wall Street has taken ETFs far beyond their original design, and the Invesco Building & Construction ETF (NYSEMKT:PKB) is a good example of how to make simple things more complex.
The name of the Invesco Building & Construction ETF is correct, but…
The first one exchange traded fund ever created was designed to follow the S&P 500 With the S&P being widely considered “the market,” it was a great way for investors to get exposure to stocks in a very simple way. Wall Street rushed to launch more index ETFs once it became clear that the ETF concept would work.
A construction worker leaning against a wall with people in the background looking at blueprints.
Image source: Getty Images.
The problem is that there are only a limited number of well-known indices. So the next step was to slice and dice the indices. For example, you can buy each of the 11 individual sectors within the index. S&P 500 via SPDR Sector Select ETFs. But that’s not the only way to slice the market, and Wall Street has been quick to introduce factor funds. These investment options break down indices based on factors like value and growth. As you might expect, you can buy an S&P 500 growth ETF and an S&P 500 value ETF. Other factors have also been introduced, such as dividend yield and dividend growth, among others.
And now you can buy ETFs that combine sector investing and factor investing, just to keep you on your toes. The Invesco Building & Construction ETF does just that (and more, keep reading). As the name of the Invesco Building & Construction ETF clearly indicates, it’s designed to give investors broad exposure to the building and construction sectors, if that’s what you’re looking for.
But the index takes into account a unique “methodology” that evaluates companies on a quarterly basis based on “price momentum, earnings momentum, quality, management action, and value.” Across all of these broad categories, 47 different metrics are evaluated. The basic goal is to select the best stocks in the building and construction sector. That’s all well and good, but as an investor, you’ll have no way of really knowing why the ETF selected a particular stock.
The Invesco Building & Construction ETF goes even further
So far, the logic, while complex, seems perfectly logical. Who wouldn’t want to buy the best stocks in a sector they like? But the alchemy of Wall Street doesn’t stop there. The Invesco Building & Construction ETF also takes a unique approach to weighting stocks in the portfolio.
The universe of possible stocks is divided into large and small companies. Eight of the top-ranked large companies are included in the fund with a total weighting of 40%. Each stock receives approximately 5% of assets. The remaining 60% of the portfolio’s assets are divided among 22 smaller companies, each receiving just under 3% of its allocated assets. This is the general weighting methodology, which may be adjusted slightly based on the unique circumstances of each sector covered by Invesco. The basic idea is to ensure that performance is not solely driven by the largest stocks in a sector.
All this extra work increases the expense ratio of the ETF, which is around 0.62%. This is quite high for an ETF, given that SPDR S&P 500 Exchange Traded Fund has an expense ratio of just 0.09%. Some ETFs have even lower expense ratios. So you’re paying for Invesco’s complex machinations.
More than the eye can discern
Is the Invesco Building & Construction ETF a good ETF to buy? It depends. You need to look for a very specific investment exposure and understand that you are not buying a simple index. The Invesco Building & Construction ETF incorporates a lot of additional information when selecting stocks for the portfolio and does not have a simple weighting approach. In other words, the Invesco Building & Construction ETF has made the ETF concept much more complicated and it is simply not as simple as “now you have exposure to construction and building companies.”
Invesco offers a range of similarly designed sector ETFs. They may be perfect for you, but you should make sure you understand how these ETFs work before buying one.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.