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Fund Spy

Waiter, There's a Closed-End Fund in My ETF!

Expect the unexpected when looking at narrow ETF portfolios.

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What's in your exchange-traded fund? The question seems easy enough. Not only is it simple to find the holdings of most ETFs because they are index funds whose constituents are published for the world to see, but ETF names also appear to telegraph their contents. There's not much doubt what benchmark the  iShares S&P 500 Index (IVV) tracks or that  streetTracks Gold Shares (GLD) owns gold bullion. Alas, appearances can be deceiving. A number of ETF portfolios include stocks that might surprise investors who thought they were getting pure exposure to the industry or the sector specified in the ETF's name.

Take the  Technology Select Sector SPDR (XLK), for example. The sector bellwethers are there-- Microsoft (MSFT),  Cisco Systems (CSCO), and  Google (GOOG)--but so are a couple of massive telecommunications service providers. Indeed,  AT&T (T) and  Verizon Communications (VZ) are both top-10 holdings and help give this fund a bigger telecom stake than any other conventional or exchange-traded technology fund. In 2006, this was a virtue as service providers rebounded sharply. That hasn't and won't always be the case, though. This ETF can look out of step with other funds tracking the tech sector when big telecom stocks lag or fall, as they did in 2005.

The proliferation of ETFs tracking narrowly defined indexes has made it more important to be on the lookout for such idiosyncrasies. Often ETFs and their indexes slice their market segments into such small slivers that there aren't enough viable, liquid stocks left to populate a diversified portfolio. Index engineers then often fill out the benchmark with securities that, at best, offer only indirect exposure to the area in question.

Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.