Services Sector ETF: Meaning, Examples, Pros and Cons

What Is a Services Sector ETF?

A services sector ETF is an exchange-traded fund (ETF) that aims to replicate the returns of an underlying services sector index, a hypothetical portfolio representing the industry, by investing in the same basket of securities that are measured in the index. To achieve this goal, these funds invest primarily in the consumer services or financial services sector of the economy.

Understanding a Services Sector ETF

ETFs are professionally managed portfolios that pool assets from investors with similar goals. They are listed on exchanges, trade throughout the day just like ordinary stock, and offer investors the possibility to mimic the performance of the broader equity market or a specific sector or trend by mirroring the holdings of a designated index.

A services sector ETF profits or declines based on the results of an underlying group of companies that supply intangible services to the population. A wide variety of companies fit this bill, ranging from consumer services firms such as internet service providers (ISPs) to financial institutions (FIs) that deliver financial services and experience-based companies, including hotels and theme parks.

Though diverse, the services sector and its incumbents generally have one thing in common: they tend to be cyclical, rising and falling with the business cycle. Consumers are more likely to take advantage of the full range of products that services companies offer when the economy is doing well.

When it is not, and people find themselves forced to cut costs to either make up for lost wages or increase savings, they will almost certainly look to eliminate these types of discretionary, non-essential expenses from their shopping lists.

Consumers may decide to do away with cable television or keep a more limited cellular package. They might also feel less inclined to take on personal loans or mortgages during these times.

Examples of Services Sector Companies

Consumer Services

Multinational telecommunications conglomerate Verizon Communications Inc. (VZ) falls into the category of a consumer service company. Although it sells tangible goods such as cell phones, the majority of its products are service-based.

Financial Services

Financial service companies such as Schwab also form part of the services sector. Aside from its brick-and-mortar locations, pretty much everything else Schwab provides is non-physical services, including financial advice, loans, bank accounts, and credit cards.

Advantages and Disadvantages of a Services Sector ETF

Investors keen to take advantage of an upturn in economic activity should certainly consider adding the services sector to their portfolios — and using an ETF to get exposure. Generally speaking, these funds offer low expense ratios, flexible trading, decent liquidity, and tax efficiency, making them one of the cheapest, most practical tools to profit from a particular part of the market and reduce company-specific risk.

Beware, though, that not all services sector ETFs will be the same. The industry is a diverse one and expense ratios and individual mandates could differ significantly.

Some of these ETFs might incorporate overseas securities, be less rigorous about replicating their designated index, skew weightings toward a handful of big companies, and generally favor targeting a particular type of stock within the industry. Others, meanwhile, might provide leveraged exposure, using financial derivatives and debt to increase the impact of price movements.

The Bottom Line

A services sector ETF is a basket of bonds or equity securities consisting of consumer services companies, such as banks, retailers, restaurant chains, and other service-sector businesses. There are many such ETFs, each with its own criteria for inclusion. As with any other security, it is important to research these ETFs carefully before making an investment.