ETF Talk: Technology Fund Positioned to Outperform S&P

The ongoing global economic slowdown has impacted nearly every sector, including information technology companies. But that sector benefits from new smartphone rollouts and other technology innovations. For those reasons, the sector may warrant higher valuations than it has been receiving lately. The Vanguard Information Technology Index Fund (VGT) is an exchange-traded fund (ETF) that may let investors collect sizable returns as the information technology sector rises and equities rebound.

Beginning the year at $62.23 a share on Jan. 3, VGT pushed upward through the first and second quarters, hitting a yearly high of $74.94. Despite slight declines in May and June, the fund remains up 11.3% year-to-date. Closing at $68.94 on July 31, 2012, VGT is trading above both its 50- and 200-day moving averages, indicating a clear uptrend.

The Vanguard Information Technology Index Fund (VGT) uses an indexing investment approach that is designed to track the performance of the MSCI US Investable Market Index (IMI)/Information Technology 25/50, an index composed of stocks of U.S. companies in the information technology sector. Compared to various companies within the IMI Index, VGT’s holdings primarily consist of true information technology companies. A whopping 43.7% of the fund’s total net assets come from just five companies, so VGT’s performance is tied heavily to those industry leaders. VGT’s top five holdings, and the percentage of the fund they encompass, are: Apple (AAPL), 18.0%; International Business Machines (IBM), 7.95%; Microsoft Corp. (MSFT), 7.89%; Google Inc. (GOOG), 5.30%; and Intel (INTC), 4.63%.

Despite lower-than-expected earnings, all of the companies have significant potential to boost sales and revenue growth through the release of new products during the second half of 2012. The new products are expected to include Apple’s iPhone 5 and Google’s Nexus 7. With nearly half of the fund’s holdings consisting of the five biggest IT companies, VGT is a sector-specific fund that is much less diversified and exposes investors to heightened risks, compared to many other ETFs. Still, with an historic track record of information technology companies outperforming the S&P 500 Index, VGT remains an intriguing opportunity. The following five-year performance chart gives a visual comparison between VGT, Technology Select Sector SPDR (XLK) and the S&P 500. As you can see, VGT leads the way.

Another plus for VGT is that its low portfolio turnover rate of 6% allows investors to pocket more of their gains and provides an additional advantage compared with similar funds. Also, as indicated, VGT offers a total annual operating expense rate of 0.19%, which is 88% lower than the industry average. It is my expectation that VGT’s holdings could help investors to profit nicely in a recovering economy.

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