SPDRs Get More Specific: a Look at the New ETFs XLFS and XLRE

When a proprietary blend of herbs and spices works for you for 17 years, people are going to take note when you finally tweak with the recipe. That's what's going on in the world of exchange-traded funds, where State Street Global Advisors has added a pair of new ETFs to its lineup of Select Sector SPDRs for the first time since rolling out the products in 1998.

As of this month, the Financial Services Select Sector SPDR Fund (ticker: XLFS) and the Real Estate Select Sector SPDR Fund (XLRE) are open to investors. For those looking to make more specific sector bets, this is a clear notch in the "W" column.

The birth of two new funds. For 17 years, the Financial Select Sector SPDR Fund (XLF) was the sole financial sector offering in the SPDR camp, providing a blend of companies such as banks and insurance companies. But also lumped into this group was real estate investment trusts -- companies that own and operate real estate, or in some cases own mortgages.

However, the marriage of financial companies and REITs was never a perfect one, and the two are formally splitting as of next year.

"The real impetus for this came as part of the Global Industry Classification Standard, which is jointly implemented by Standard & Poor's and MSCI [Morgan Stanley Capital International]," says Dave Mazza, head of research for SPDR ETFs and SSGA Funds at State Street Global Advisors. "Throughout this process they made a decision that in August 2016 they would actually be splitting real estate out from the broader financial industry and moving it into its own sector."

In response, State Street has launched XLRE and XLFS, which won't replace XLF in the SPDR lineup, but simply join it. XLF has banks, insurance companies, capital markets companies, diversified financial services, consumer financial companies, mortgage finance, REITs and real estate management companies. XLRE and XLFS will divide that pot -- XLRE will have the REITs and real estate management and development companies, while XLFS will contain the rest.

Here's a closer look at each of the new funds.

Real estate lands in XLRE. The XLRE is going to be a real estate-focused fund that invests in real estate investment trusts (excluding mortgage REITs) as well as real estate management and development companies.

It's a relatively small fund, at just 25 holdings, and somewhat top-heavy as the five greatest holdings comprise roughly 40 percent of XLRE's total weight. The top five holdings will be Simon Property Group (SPG), American Tower Corp. (AMT), Public Storage (PSA), Equity Residential (EQR) and Crown Castle International Corp. (CCI).

The top-heaviness isn't much of an outlier -- you get much of the same from similar funds such as the Schwab U.S. REIT ETF (SCHH) and the Vanguard REIT ETF (VNQ) -- though those other offerings are much more diversified at 97 and 145 holdings, respectively.

And naturally, the yield-happy nature of REITs shines through in the fund's yield, which is projected at about 3.3 percent based on its underlying index.

XLFS is for banking and insurance stocks. The XLFS is actually going to look a heck of a lot more like the XLF, especially at the top. The two funds share nine of the same top 10 holdings, led by roughly 10 percent weightings in Berkshire Hathaway (BRK.A, BRK.B), Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM).

XLFS is now a cleaner, purer financials fund, with more than half of the fund dedicated to banking and another hefty allocation to various insurance companies.

The downside of this? The yield suffers a bit, as the already modest 2.1 percent of the XLF drops to 1.9 percent based on XLFS' underlying index.

Why XLRE or XLFS? It bears repeating that XLF isn't going away. If you hold XLF and like the exposure it provides, nothing is booting you out of that fund.

However, XLRE and XLFS offer more specific exposure to two very different sectors -- something that's getting a thumbs-up in the financial space.

"From the perspective of an individual investor, this allows for greater focus in specific areas rather than having to buy a benchmark that may contain sub-optimal holdings," says David Fabian, managing partner and chief operations officer of FMD Capital Management in Irvine, California. "Now ETF holders can fine tune their financial industry exposure to include specific groups of stocks that may prove to be more beneficial under specific circumstances. For instance, XLRE may be more attractive in a falling interest rate environment, while XLFS may perform better in a rising interest rate environment."

Chris Johnson, director of research at JK Investment Group in Independence, Ohio, agrees.

"The sector-focused construction of these exchange traded funds allows investors to make sure that they get what they are paying for," he says. "In the past, many sector-based ETFs have included less-related companies for a number of reasons, these new offerings have a laser-like focus on their component companies, which is great for the sector investor."

Moreover, both funds charge just 0.14 percent in fees (backing out a small expense waiver), which comes out to just $14 annually on every $10,000 invested, so they're individual-investor-friendly.

"With average ETF management fees above 0.5 percent, and mutual fund fees above 1 percent, a management fee of less than 0.15 percent is welcome to the investor and helps their bottom line," Johnson says.