Keep your virtual shirt in the tech game

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Millions - soon to be billions - of people use Facebook as their only communication tool with friends. Suddenly, information technology is not just big, it's game-changing.

And yet, the sector has frustratingly never been an easy place to plunk one's dollars and watch them grow from megabytes to terabytes. Companies such as Apple and Google have rewarded investors handsomely; Global Crossing and 360networks have, on the other hand, failed spectacularly. For every bright star, it seems, there's a black hole.

Even the sector's most successful companies encounter incredibly rough patches. Intel recently announced it will spend up to $700-million to correct a design flaw in a new chip. So, while there is clearly money to be made, how to do you invest in tech without losing your virtual shirt?

Technology exchange-traded funds (ETFs) are an attractive, low cost alternative to tech stocks. They invest in a basket of tech stocks that are part of a benchmark index. The objective is to provide investors with the returns of the stocks in the index minus fund expenses. Two Canadian- and several U.S.-listed ETFs are based on benchmark indices that are heavily weighted with technology companies.

The iShares S&P/TSX Capped Information Technology Index Fund is the only ETF that tracks Toronto Stock Exchange-listed companies in the information technology sector. It's based on the S&P/TSX Capped Information Technology Index. The fund holds just five companies - CGI Group Inc., Research in Motion Ltd., Open Text Corp., MacDonald Dettwiler and Associates and Celestica Inc. The management expense ratio is 0.55 per cent. It has not paid a distribution since December, 2008. This ETF has tracked its benchmark index closely; however, returns have been low compared with other tech ETFs.

The Canadian stock market is notoriously short of technology companies. Consequently, XIT is a poor representation of the many companies around the world involved in this rapidly growing sector. Investors need to look to ETFs that invest internationally for more diversified exposure.

The BMO NASDAQ 100 Equity Hedged to CAD Index ETF is likely the better choice of the two Canadian-listed technology-rich ETFs, experts say. This fund seeks to track the performance of 100 of the largest non-financial securities (based on market capitalization) listed on the NASDAQ stock exchange.

While it's not exclusively a technology fund, 65 per cent of the holdings are in this sector. All the big name U.S. information technology companies are represented including Apple Inc., Google Inc. Class A, Microsoft Corp., Oracle Corp., Amazon.com Inc., Cisco Systems Inc. and Intel Corp. There is even a smattering of U.S.-listed foreign stocks such as Canada's Research in Motion and Baidu Inc. ADR, the Chinese-language Internet search provider. The management expense ratio is estimated at 0.37 per cent. It pays a small yield of about 0.60 per cent, distributed annually.

ZQQ was launched in January of 2010, so it lacks a performance track record. Still, Canadian investors should take a look, given that it tracks a well established benchmark and the impact of currency exchange rates is removed by hedging to the Canadian dollar.

A large selection of technology ETFs is listed on U.S. stock exchanges. Unlike American mutual funds, U.S.-listed ETFs can be purchased by Canadian investors. The procedure is the same as buying a U.S.-listed stock. Note that currency exchange fees will be charged when you convert Canadian dollars to make the purchase and these ETFs are subject to exchange rate fluctuations.

The ETF database website, etfdb.com, lists 25 unleveraged technology ETFs. These can be grouped into broad technology sector funds and ETFs invested in specific sub-sectors such as software, semi-conductor, Internet, networking and China technology. For reasons of cost, adequate diversification and liquidity, broad technology funds are a good choice for the average investor. The top five ETFs of this type based on market capitalization are: Technology Select Sector SPDR (XLK), Vanguard Information Technology (VGT), iShares Dow Jones U.S. Technology Sector Index (IYW), iShares S&P Global Technology and First Trust NASDAQ-100-Technology Index.

The top 10 holdings of XLK, VGT and IYW represent at least 50 per cent of each fund and consist of almost the same 10 U.S. technology companies. It's no surprise then that the returns for these three funds are similar. The iShares S&P Global Technology ETF, which includes tech stocks from countries around the world, has not performed as well as ETFs holding U.S. technology companies. First Trust NASDAQ-100-Technology Index Fund has posted excellent returns but has a shorter track record, holds a limited number of stocks and has the highest MER of the group.

Based on diversification, ability to tightly track the returns of its benchmark index and a low MER, the best pick from among these five ETFs is the Vanguard Information Technology ETF . The fund's benchmark index, the MSCI U.S. Investable Market Information Technology 25/50 Index, consists of more than 400 U.S. companies of all sizes covering every area of the technology sector. Its top 10 holdings include some of the biggest names in tech: Apple Inc., Microsoft Corp., International Business Machines Corp., Google Inc. Class A, Oracle Corp., Intel Corp. and Cisco Systems Inc. The fund has a history of tracking its benchmark index closely. The management expense ratio at 0.24 per cent is one of the lowest in this group of ETFs. It even pays a small dividend of about 0.40 per cent, distributed annually.

Special to The Globe and Mail