Serendipity is a beautiful thing. The recent sell-off in the technology sector made for a perfect demonstration of why seemingly arcane subjects like the capitalization weighting of stocks within exchange traded funds matters. There have been a couple of days lately where S&P 500 indexed funds – which contain the exact same stocks, but in different proportions – saw their performance bifurcated. Meaning, one ETF went up, while others declined. All this is explained in the post below this one.
So, now we’re going to talk about an adjustment in sector allocations that I made about a month ago inside a couple of IRAs. First, I am not suggesting you make this shift in your personal accounts. Second, please note that one reason for making these changes was purely emotional.
For me, one of the more confusing designations is the distinction between Consumer Staples versus Consumer Discretionary. A comparison of these two sectors using Vanguard ETFs helps explain the good and bad of augmenting a pure S&P 500 ETF with additional holdings. VCR is a consumer discretionary EFT with 374 individual stocks, though the top 10 holdings comprise 50% of the total valuation. VDC is a consumer staples ETF with 107 stocks and the top 10 holdings representing a whopping 60% of the fund.
My confusion revolves mostly around why any individual stock is considered a “staple” as opposed to a “discretionary” choice that consumers can make. For VDC (staples) the largest position at 10% of the fund is Proctor & Gamble (PG). With 65 consumer brands, twenty-one that each generate over $1-billion in annual sales, most folks probably need something from their product lines (laundry, baby care, feminine care, and grooming). But the other four stocks in the top five holdings, comprising a third of the entire fund, are either tobacco companies or soft drink manufacturers. How cigarettes and sodas can be classified as “consumer staples” elude me completely. An additional holding is Molson Coors Brewing. While beer strikes me as a perfectly acceptable daily requirement, it is safe to assume most people would disagree.
For VCR (discretionary) the largest holding is Amazon, weighing in at 12% and Home Depot a distant second at 6% of the fund. That Home Depot provides more products necessary for day-to-day living, as a home owner or a renter, than a brewery or cigarette vendor seems to be stating the obvious. Another top five holding is Disney (DIS) and lots of people like cartoons, Star Wars and theme parks.
Now, a quick interlude focused on the S&P 500, the favorite proxy for U.S. equities here at Invest-Notes. The stocks included in the S&P are, mostly, the largest and most respected companies in the U.S. However, smaller companies tend to outperform large cap(italization) stocks over time. But as a group smaller cap stocks tend to be more volatile, and hence riskier for individual investors. Sector funds can provide exposure to smaller companies while increasing exposure to the core holdings of pure S&P funds.
In May I sold all of the VDC funds in two IRAs and redeployed the proceeds into VCR. Here is a quick summary of the reasons that drove this decision. Understand that this list gives the conclusions of my thinking, not the information that underpins these statements.
- Diversification is better achieved since VCR has over 370 stocks and VDC only 107
- Individual equities in VCR are more appealing based on current consumer trends, like the shift toward online purchases (Amazon), increasing home ownership (Home Depot) and a preference for experiences over stuff (Disney)
- Personally, I don’t want to own businesses that hurt their customers – tobacco and soft drinks
- As for beer, I’ve been a longtime owner of Heineken stock and will remain so