Money Management Executive caught up with ETF industry veteran Dan Dolan, who spoke about a transition in the industry to constructing client portfolios using sector weights, as opposed to style and size weightings. Dolan, director of wealth management strategies at Select Sector SPDRs, said assets are up almost $20 billion YTD. 

How did you get into this space?

I worked at Merrill Lynch for 18 years. In 1998 we were looking at the growth of indexing and ETFs. The idea was to take the S&P 500 and carve it into nine ETFs, giving advisors the ability to customize their client portfolios based on objectives. 

What can others learn from you?

The world has looked at the mutual fund business through Morningstar'sstyleboxes,which dominates the way many advisors and investors look at portfolio allocations. What we're seeing is the movement to constructing portfolios using sector weights, as opposed to size and style weightings (i.e., large-cap value; large-cap growth). Many people are realizing you don't get much diversification with large-cap value versus large-cap growth. There are greater diversification benefits with allocating sectors. As an example the technology and utility sector have very low correlation and move in different directions. 

What are the nine sector ETFs? Why did you choose those sectors?

The Sector SPDR Trust divides the S&P 500 into nine ETFs, giving investors the ability to customize the large-cap portion of their portfolio. S&P 500 Index Funds and ETFs have been available for years; we merely gave investors the unique opportunity to invest in the specific sectors that they consider most attractive. In December, we will celebrate our 15th anniversary with current total assets of approximately $70 billion.The nine sector SPDRs are: XLY - Consumer Discretionary, XLP - Consumer Staples, XLE - Energy, XLF - Financials, XLV - Healthcare, XLI - Industrials, XLB - Materials, XLK - Technology and XLU - Utilities. 

How have they performed?

The nine Sector SPDRs have all delivered performance consistent with their corresponding index, minus expenses. Our expenses have been reduced as assets have grown. The current expense ratio is 0.18%, down from 0.65% at inception. 

Do you plan on introducing other ETFs?

We do not plan on offering new products. We were early when we launched in 1998 and being first movers in the sector space is clearly an advantage. We represent approximately two-thirds of the assets and more than 90% of the daily trading volume of all sector ETFs. There were approximately 20 ETFs trading in December 1998. Today, there are more than 1,400. 

What are the biggest trends you're seeing in the space?

The big players continue to get bigger in the ETF space. iShares, State Street and Vanguard dominate while many others struggle to gather assets. The large asset products have low expenses and the trend is lower. 

Why do you believe ETFs are cannibalizing not just the mutual fund industry but single stocks as well?

Total industry-wide sector ETF assets are up 38% in the last year. This growth is coming from financial professional building model portfolios based on customized sector weightings and investors buying ETFs in place of equities. Many investors are opting for the diversification a sector ETF can provide while they try to minimize single stock risk.

Who do you consider to be "innovators" within the space? Why?

Innovation died years ago in the ETF space. ETF inventor Nate Most and folks at the American Stock Exchange deserve all the credit for the structure. This is a copycat business now. It's all about distribution.

Where are the top opportunities for ETFs and mutual funds?

The best opportunities for mutual funds and ETFs will likely be products delivering exposure to growth areas of the world in low cost, transparent structures. In addition, the search for yield will continue as income is tougher to find. Low volatility products that can payout consistent dividends will attract huge assets.

ETF providers are increasingly creating funds that invest in the IPO market. Why?

The IPO market heats up and then cools down. Recent technology deals have traded well and many investors are looking at mega-deals like Twitter coming soon. Everyone wants a piece of the action but it comes at a cost. Many IPOs do not trade well and the good ones, you can't get shares allotted on the offering. The only way for many to participate is in the after-market when the shares begin to trade. Mutual funds and ETFs will have a hard time finding shares at the offering price, particularly index based. It can't be in the index until it starts to trade.

Buying IPOs soon after they start to trade is not a good strategy. We have no interest in developing product around IPOs.

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