Imagine you order a pizza with mushrooms and onions…
And the delivery driver instead brings a pizza with sausage and pepperoni.
I bet you would be angry. You would likely demand a refund. And you would probably get it.
Now, don’t get me wrong…
Sausage-and-pepperoni pizzas are popular. And many folks think mushroom-and-onion pizzas are disgusting.
But maybe you’re a vegetarian. Or perhaps it’s just a personal taste.
The point is… no matter what, you deserve to get the pizza you ordered. The delivery driver shouldn’t get to decide for you.
Truth in labeling is standard practice in the real world. Consumers expect to get what they pay for. If not, they’re entitled to a refund.
However… this practice isn’t always followed in the investing world.
Specifically, as an investor, you should be careful about thematic exchange-traded funds (“ETFs”). As I’ll explain today, some of these ETFs come with eyebrow-raising portfolios…
Take the ARK Space Exploration & Innovation Fund (ARKX), for example…
As you can tell from its name, ARK Investment Management operates this ETF.
It holds tractor maker Deere (DE), as well as tech giants Amazon (AMZN) and Alphabet (GOOGL). And at one time, it even held streaming-media powerhouse Netflix (NFLX).
In another odd twist, ARK Investment Management’s 3D Printing Fund (PRNT) is ARKX’s fifth-largest holding. That’s right. One of ARK’s ETFs makes up 5.7% of another.
Now, legally, this is OK. ARKX’s prospectus permits so-called “aerospace beneficiary companies.” So as weird as it might be, the company has checked all the boxes.
But ARK Investment Management isn’t alone. Mission-stretching happens all the time with thematic ETFs. And as an investor… you need to know what type of “pizza” you’re getting.
Last week, I explained why the Consumer Discretionary Select Sector SPDR Fund (XLY) is riskier than many ETF investors expect. It’s weighted far too much to Amazon and electric-car maker Tesla (TSLA). These two stocks hog nearly 39% of the 56-stock portfolio’s assets.
As an investor, you’re prepared for a massive sell-off when you buy individual stocks. But with supposedly diversified ETF portfolios, you’re likely not expecting a lot of volatility.
And even if you accept that type of risk, XLY still doesn’t work…
You see, it’s not a proper tracker of the consumer-discretionary sector. It’s not the pizza that investors ordered.
Now, strictly speaking, Amazon and Tesla are consumer-discretionary stocks. But they’re atypical…
Tesla isn’t a garden-variety car company. It’s way out in front of the pack with electric vehicles.
And Amazon isn’t just a traditional retailer…
Retail only contributed 41% of the company’s operating profits in the pandemic-plagued 2020. Even with lockdowns boosting folks’ at-home purchases, it wasn’t any higher.
As the lockdowns eased in 2021, retail only made up 26% of operating profits. And in 2022, Amazon lost money in this segment.
Amazon’s main profit driver is Amazon Web Services. That’s the company’s “cloud” operation.
In other words, with mega-stakes in Amazon and Tesla, XLY is more like a technology play. It’s not the best representation of the consumer-discretionary sector.
Again, it’s not the pizza that investors ordered.
Let me be clear…
I don’t object to Amazon and Tesla being in XLY. They are consumer-discretionary stocks. Rather, I object to their massive stakes drowning out other important areas of the sector…
Consumer discretionary also includes stocks like Target (TGT), Ford Motor (F), Royal Caribbean (RCL), Starbucks (SBUX), Lennar (LEN), Nike (NKE), and Dollar Tree (DLTR).
None of these companies make up more than 5% of XLY. And yet, Amazon and Tesla combine for nearly 39%.
That feels like “bait and switch” to me.
Folks who want mushroom-and-onion pizza shouldn’t get sausage-and-pepperoni pizza. And people who invest in a consumer-discretionary ETF shouldn’t get a pseudo-technology ETF.
At the end of the day, ETF providers and pizza places should deliver what buyers order.
Good investing,
Marc Gerstein
