Top Ranked Technology Sector QTEC ETF In Focus [Technology SPDR (ETF), PowerShares QQQ Trust, Series 1 (ETF)]

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March 9, 2014 11:12pm NASDAQ:QTEC NYSE:XLK

ETF SpotlightAfter lagging for most of 2013, technology stocks have shown a nice comeback with substantial improvements in earnings and revenue growth rates as well as beat ratios. Shares of large cap

companies are surging with most of them hitting new highs.

In fact, technology has been the second best performing sector with an earnings beat ratio of 85.7% and revenue beat ratio of 76.8%, trailing aerospace which saw an earnings and revenue beat ratio of 88.9% each. Total earnings for the S&P 500 tech companies that have reported so far are up 5.6% on an annual basis while revenues increased 5.2%.

This is especially true given that some of the top players such as Facebook (FB), Microsoft (MSFT), Cisco (CSCO), Oracle (ORCL), Google (GOOG), F5 Networks (FFIV) either emerged winners on both revenue and earnings fronts, or have shown an incredible run in their share price (read: 3 Tech ETFs to Watch on the Microsoft Earnings Beat).

Further, improving fundamentals across the globe are fueling growth in the tech stocks. Overseas demand is improving and global IT spending is rising while the dollar is weakening on soft U.S. data. Market fundamentals for the firms that make products ranging from networking equipment to mobile-phone components are also rebounding.

Given bullish trends in the entire industry, it is prudent to focus on the broad play rather than a specific corner of the space. One way to find a top ranked ETF in the tech space is by using the Zacks ETF Ranking system.

About the Zacks ETF Rank

A look at the top ranked tech ETFs can be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box or asset class. Our proprietary methodology also takes into account the risk preferences of investors.

The aim of our model is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other ETFs with a similar level of risk.

Using this strategy, we have found one ETF – First Trust NASDAQ-100-Technology Sector Index (NASDAQ:QTEC) – that has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a ‘Medium’ risk outlook.

QTEC: A Strong Buy

This ETF offers broad exposure to the tech sector of the U.S. equity market by tracking the NASDAQ-100 Technology Sector Index. In total, the fund holds a small basket of 40 securities that are weighted equally with no single company making up for more than 3% share in the basket.

The best thing about the equal weight approach is that performance is not heavily dependent on the returns of a particular stock or group of securities. Further, with quarterly rebalancing, equally weighted stocks tend to cash in on the overvalued sub-segments and reinvest in the underperforming ones, potentially allowing for outperformance if the trends reverse.

The product has a tilt toward the large cap and growth stocks as about 90% of the portfolio falls in the large cap category while about half of it is classified as growth. NXP Semiconductors (NXPI), FFIV, Akamai Technologies (AKAM), Facebook and Adobe Systems (ADBE) occupy the top five positions in the basket.

With respect to sector holdings, about two-fifths of the portfolio is allocated to semiconductors while software and Internet take decent allocations of, respectively, 24.29% and 12.84% in the portfolio. Computer hardware, telecom equipment and computer services make up for the rest with single-digit allocations.

In terms of performance, QTEC added over 5% year-to-date, easily crushing the broad tech fund (NYSEARCA:XLK) and U.S. market fund (SPY) by wide margins. Further, the ETF is up 34.54% over the trailing one-year period and 34.19% over the past three years (read: 3 Sector ETFs Braving the Market Slump).

QTEC: Medium Risk

While the ETF will have to go a long way in reducing overall risk, it charges a higher expense ratio of 60 bps compared to the fundamentally/capitalization weighted counterpart. The fund has so far accumulated a decent $202.3 million in its asset base but is often overlooked by investors as depicted by its small volume of roughly 30,000 shares per day.

This suggests that bid/ask spreads are relatively wide and that total costs may be higher than the expense ratio.

Bottom Line

Though the fund is a bit costly and the volume is low, this fund could be an ideal choice for investors seeking higher returns from the booming tech industry given its solid performance history and diversified exposure.

Moreover, favorable industry-specific trends and a supportive global macroeconomic environment will continue to provide a boost to this ETF in the coming months, making QTEC an interesting pick for tech-focused investors.

This article is brought to you courtesy of Eric Dutram.

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