Investors often mix up sector ETFs and commodity ETFs. It’s understandable – they’re both types of exchange-traded funds (ETFs) with unique purposes. But while sector ETFs focus on specific industries, commodity ETFs provide exposure to raw materials like gold, oil, and agricultural goods.

Each ETF type offers different benefits and risks, attracting investors for unique reasons. This article explores how sector and commodity ETFs compare, their potential advantages and risks, and what each type can add to a portfolio. It’s packed with information to help you understand how these two ETF types work and how they might suit different investment goals.

What is a sector ETF?

A sector-focused ETF allows you to tap into specific industries like healthcare, technology, or financial services without picking individual stocks. With one investment, you can gain exposure to an entire sector’s potential, capturing industry trends while spreading your risk across several companies.

For investors who see promise in certain industries, investing in a sector ETF can be an appealing choice. Many of these funds are available on major exchanges like the Australian Securities Exchange ASX) , making it easy to find an option that aligns with your interests.

The variety within sector ETFs means you have plenty of options, whether you’re interested in energy, consumer goods, or real estate. This flexibility lets you focus on areas you believe in whilst potentially diversifying your portfolio to manage risk.

Here are some examples of popular sector ETFs:

1. VanEck Vectors Australian Banks ETF (ASX: MVB) : Focuses on Australia’s major banks, providing exposure to the financial sector.
2. BetaShares Global Cybersecurity ETF (ASX: HACK) : Targets the cybersecurity industry with global tech companies at the forefront of digital security.
3. SPDR S&P/ASX 200 Resources Fund (ASX: OZR) : Provides exposure to Australia’s resources sector, including mining and materials companies.
4. VanEck Global Healthcare Leaders ETF (ASX: HLTH): Offers investors exposure to some of the world’s largest and most innovative healthcare companies.
5. BetaShares Australian Resources Sector ETF (ASX: QRE) : Another option for investors interested in Australia’s resources sector, with a broader range of resource-related companies.

Each of these sector ETFs allows investors to focus on specific industries.

What is a commodity ETF?

As mentioned earlier, a commodity ETF lets you invest in raw materials like gold , oil, or agricultural products without buying the physical assets. This type of ETF often tracks the prices of specific commodities – useful for investors wanting direct exposure to global resource markets.

Some commodity ETFs hold futures contracts – an agreement to buy the underlying commodity at a future agreed time. Others may include companies involved in producing those commodities. This distinction can impact how a commodity ETF behaves, especially during market fluctuations.

For investors concerned about inflation, commodities like gold can offer a unique edge . Commodities often perform differently than stocks, which may potentially help balance a portfolio.

A commodity ETF can come in many types, giving options for everything from precious metals like silver ETFs to energy sources like natural gas. This variety lets investors choose specific resources that align with their goals or view of the market.

Here are some popular commodity ETFs:

1. Goldman Sachs Physical Gold ETF (NYSE: AAAU) : Provides investors with direct exposure to gold by holding physical gold bars as a potential hedge against inflation.
2. BetaShares Crude Oil Index ETF - Currency Hedged (ASX: OOO) : Tracks the performance of crude oil prices through futures contracts, giving exposure to the energy sector.
3. ETFS Physical Silver (ASX: ETPMAG) : Holds physical silver bullion, allowing investors to participate in the silver market without holding the metal themselves.
4. BetaShares Global Agriculture ETF - Currency Hedged (ASX: FOOD) : Offers exposure to leading global agriculture companies involved in the production, processing, and distribution of agricultural products, with currency hedging to reduce foreign exchange risk.
5. VanEck Australian Resources ETF (ASX: MVR) : While technically a sector ETF, it provides exposure to Australian companies involved in mining and producing commodities like gold, iron ore, and coal.

This variety of ETFs caters to various commodity interests and lets investors choose specific resources that align with their goals or view of the market.

Key differences between a sector vs commodity ETF

While both sector and commodity ETFs focus on specific market areas, they differ in what they track and how they operate.

A recap of underlying assets

• Sector ETF : Primarily hold company stocks within a specific industry. These ETFs depend on the performance and growth of companies in the chosen sector.
• Commodity ETF : Track physical commodities (like gold or silver) or futures contracts on raw materials. Rather than focusing on companies, these ETFs track the value of the commodity itself.

Market drivers

• Sector ETF : Influenced mainly by industry trends, consumer demand, and broader economic conditions. Sector performance can rise or fall based on economic cycles, innovation, and competition within the industry.
• Commodity ETF : Heavily driven by supply and demand for the commodity, which can be influenced by factors like global demand, production levels, and environmental conditions. Commodities also respond to currency fluctuations and global trade policies.

Risk and volatility

• Sector ETF : Risks are typically tied to the economic cycle and industry-specific changes. They may be affected by shifts in consumer preferences, regulatory changes, or competitive pressures within the sector.
• Commodity ETF : Often more volatile due to sensitivity to geopolitical events, weather patterns, and sudden supply disruptions. Commodities like oil or metals can experience sharp price swings, especially during economic or political instability.

Advantages of investing in sector ETFs vs commodity ETFs

When choosing between sector ETFs and commodity ETFs, it helps to look at what each brings to the table. Both offer potential advantages, from growth potential to inflation protection – here’s how they stack up.

Sector ETF

Commodity ETF

Growth potential : Offers exposure to industries with high growth potential, such as technology or healthcare, allowing investors to capitalise on industry trends. Portfolio diversification : Adds diversity by including multiple companies within a single sector, reducing reliance on individual stock performance. Ease of access : Widely available on major exchanges like the ASX, making it simple for investors to focus on specific sectors. Economic alignment : Sector ETFs often reflect broader economic cycles, making performance relatively predictable for those familiar with industry trends (remember, though, that past performance doesn't indicate future returns). Defensive and growth options : Can cater to different investment goals, with options in both defensive sectors (e.g. utilities) and growth sectors (e.g. technology). Reduced company-specific risk : Spreads risk across multiple companies in a sector, lessening the impact of poor performance by a single company.

Inflation protection : Commodities like gold can act as a hedge , as they often (but don't always) rise in value during inflationary periods. Diversification from stocks : Commodity ETFs provide an asset class that behaves differently from stocks, helping to balance stock-heavy portfolios. Direct exposure to commodities : Tracks commodity prices directly, allowing investors to benefit from price increases (or suffer from price declines) in raw materials without holding physical assets. A vailability on major exchanges : Many commodity ETFs, including those for precious metals or agricultural goods, are also easy to access on exchanges like the ASX. Potential safe haven : Some commodities, especially precious metals, are viewed as defensive assets , which can be attractive during market uncertainty.

Whether you’re seeking industry-specific growth or a hedge against inflation, each ETF type offers something different. The most fitting option depends on your investing strategy and what you want your portfolio to achieve.

What are the risks for each?

Investing always comes with risk, and investing in a sector ETF or commodity ETF is no exception. Here are some of the risks:

Risks of investing in sector ETFs

• Economic downturns : Sector ETFs are vulnerable to economic slowdowns, especially if the chosen industry is highly sensitive to market cycles.
• Industry-specific changes : Rapid shifts in technology, consumer trends, or regulations can affect an entire sector’s performance and drive up risks.
• Concentration risk : Focusing on one sector reduces diversification, making your investment more exposed to any downturn in that industry.
• Company reliance : If a few large companies dominate the sector, their performance significantly impacts the ETF’s overall returns.

Risks of investing in commodity ETFs

• Market volatility : Commodities can experience sharp price swings due to global supply and demand shifts, making these ETFs more volatile.
• Geopolitical factors : Political events and conflicts can disrupt commodity production, impacting supply and causing sudden price movements.
• Currency fluctuations : Changes in currency values can affect commodity prices, especially if the ETF involves global resources priced in foreign currencies.
• Futures contract risks : As mentioned, some commodity ETFs use futures contracts, which carry unique risks, including unexpected costs and rapid price changes.

While investing involves risk, understanding what to expect can make all the difference. Knowing these risks can help you decide if they align with your comfort level and objectives.

What to consider when choosing between sector and commodity ETFs

Selecting between sector and commodity ETFs requires matching your goals, risk comfort, and investment style with each fund type’s strengths. Here are a few factors to weigh before making a decision.

• Investment goals : Think about what you want to achieve. Sector ETFs might be better to capitalise on industry growth, while commodity ETFs can potentially help with inflation protection or diversification outside traditional stocks.
• Risk tolerance : As mentioned, commodity ETFs often experience sharper price swings due to global supply and demand shifts. If you prefer less volatility, a sector ETF may feel more comfortable, given its reliance on company performance within an industry. Even so, remember that no investment is devoid of volatility.
• Economic outlook : Market conditions can impact each type differently. During economic growth, sector ETFs can thrive, especially in industries like technology and consumer goods. Commodity ETFs may shine during inflationary periods or when commodities are in high demand.
• Diversification needs : If your portfolio is heavy on individual stocks, adding a commodity ETF can potentially offer balance through different market behaviours. Sector ETFs, on the other hand, can allow for further diversification within industries you’re interested in.
• Time horizon : For short-term gains, commodity ETFs might appeal due to quick price shifts. Sector ETFs, however, may potentially be a better fit for longer-term industry growth and economic cycles.
• Research and familiarity : If you’re more comfortable following industry trends, a sector ETF may feel like a natural choice. But if you prefer tracking global supply and demand, commodity ETFs might be a better option.

These considerations can help you decide which ETF type fits your unique portfolio strategy. Balancing these factors can guide you toward a choice that works for your goals and risk tolerance.

Sector vs commodity ETFs: find your match

Still deciding between sector and commodity ETFs? Each type has its perks, but there are also some trade-offs to keep in mind. By knowing the key differences, potential benefits and risks, you’re in a solid spot to make a choice that suits you. From industry growth to some extra balance with commodities, these ETFs give you options to help reach your investing goals. Decide to invest in one, both or none – the choice is all yours.

Happy investing!