Jim Cramer: Why this should be the beginning of the end for sector ETFs

CNBC's Jim Cramer said the recent market volatility is showing why sector ETFs are not always advantageous for investors.

CNBC’s Jim Cramer said Wednesday the recent market volatility should serve as the beginning of the end for sector ETFs.

“I know I’m early, but anyone who doesn’t see this index fund peak on the horizon is fooling themselves,” the “Mad Money” host said.

That realization has become evident as the stock market has reacted to growing concerns over the coronavirus, Cramer said. Within a week, the Dow Jones Industrial Average experienced both its largest one-day point decline and largest one-day point gain.

Cramer said he understands the appeal of index funds and added he’s previously been a fan of them due to the time and effort it takes to pick individual stocks.

“The whole premise of investing in an index fund is that it’s impossible to consistently beat the market by picking individual stocks, so you can’t beat it, therefore you’ve got to join it,” Cramer said.

But the problem with index funds has become their popularity, Cramer said. Around half of all funds are now indexed, he noted.

In 2009, actively managed funds had a nearly 3-to-1 advantage over passive in U.S. equity funds, according to data from Morningstar. The gap began to notably narrow in 2012 and then dropped sharply since.

“When everybody’s got that same darn strategy, that strategy rarely works,” Cramer said. “And a down market like we had last week really validates stock picking, especially for those of us who had some cash on the sidelines to take advantage of the weakness.”

Indexing still has a role in your portfolio, Cramer said. In particular, a low-cost index fund that mirrors the S&P 500 should be the “bedrock of your retirement account,” he explained.

The overall S&P 500 index works because the S&P 500 is itself an actively managed fund, Cramer said.

But sector ETFs? “They’re nothing more than fee generators,” he argued.

For evidence, look at the pharmaceutical industry, Cramer said.

“The drug ETFs have homogenized the un-homogenizable. We have some very good drug companies and some very bad ones,” he said.

It’s a similar situation with blue-chip companies such as Google parent Alphabet, Walmart, Amazon, Costco and Home Depot. These are best-in-their-industry companies that boast strong growth and quality balance sheets, Cramer said.

Cramer said the “fee-hungry brokerage industry” wants retail investors to believe it’s too dangerous to own the individual stocks of these companies. To soften the blow, the brokerage industry wants investors to pick ETFs that also include Twitter, Snap or Hewlett Packard and IBM, Cramer argued.

“That’s not softening the blow. It’s leaning into the blow,” Cramer said. “Why own both the winners and losers in an industry when you can just pick the very obvious winners?”

While sector-based index funds may have started with good intentions, the investing landscape has changed, Cramer said.

“We’re now in an environment where, for many industries, more people trade the indices than individual stocks,” Cramer said. “That creates a lot of opportunities for those of you who are willing to manage your own money.”
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