Harnessing Innovation and Growth Within Tech

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1 SPDR SPOTLIGHT Harnessing Innovation and Growth Within Tech by David B. Mazza, Head of ETF and Mutual Fund Research, Matthew Bartolini, CFA, Research Strategist, and Jared Rowley, CFA, Research Strategist, SPDR ETFs and SSGA Funds Introducing the SPDR FactSet Innovative ETF (XITK) Key Takeaways We have a positive outlook on the US technology sector based on its high growth potential in a low and slow growth world. We believe targeting innovative companies that may have the ability to disrupt industries and economies can potentially increase the overall growth profile of a tech sector allocation. Through a unique, bottom-up revenuefocused indexing methodology, XITK seeks to access segments of the tech sector and electronic media sub-sector that are innovative, defined as segments with high revenue growth, at a gross expense ratio of 0.45%.* * The gross expense ratio is the fund s total annual operating expenses ratio. It can be found in the fund s most recent prospectus. Finding Growth in the Tech Sector We believe that investors should consider overweighting the technology sector in 2016 because it offers relatively strong earnings and revenue growth potential. In both the second and third quarters of 2015, S&P 500 Information (IT) firms surprised to the upside on earnings over 75 percent of the time. 1 The sector as a whole has profit margins that are almost twice as high as the S&P helped by low debt and strong secular tailwinds from a persistent need for technology. We feel future earnings growth may be fueled by consumers and businesses restricting additional marginal spending to items that are seen as must haves. These factors make technology a potentially attractive addition to a portfolio seeking growth in a low and slow growth world. Within the broader technology sector, investors may be well served by adding a focus to innovative companies, which we define as companies with strong revenue growth generated from focused lines of business, as a method to harness the next phase of tech evolution. This means not only investing in the stalwarts of the tech space, but going beyond established tech titans like Facebook, Google and Netflix to capture newer firms focused on new cutting-edge products and services. Tech companies with robust revenue growth are often the ones that offer products and services related to rapidly evolving areas such as social and electronic media, smartphones, wearables, cyber security and cloud computing. We believe targeting such companies that may have the ability to disrupt industries and economies can potentially increase the overall growth profile of a tech sector allocation. And this is precisely what the new SPDR FactSet Innovative ETF (XITK) attempts to harness through a unique, bottom-up revenue-focused indexing methodology. A Focus on Innovation XITK seeks to provide cost efficient exposure to specialized companies engaged in high-growth markets and industries from the tech sector and electronic media sub-sector. The bottom-up revenue mapping methodology of the FactSet Innovative allows investors to capture companies within segments that have already begun to monetize their new products and services. The index is designed to identify high growth segments, which typically include firms that are raising revenue in a timely manner neither too early, nor too late in the adoption cycle. The methodology pinpoints these high-growth segments, in part, by using one-year and three-year revenue screens that together serve to establish that a trend of increasing revenue is in place for these niche areas of tech.

2 The FactSet Innovative uses a US patented and proprietary sector classification system known as the FactSet Revere Hierarchy, which is based on revenue mapping, to assign firms to specific segments of the tech sector and electronic media sub-sector. For index consideration, components must derive a substantial portion (at least 50 percent) of their revenue from a specialized segment of technology or electronic media. Overall, this unique and granular approach to industry classification in XITK s underlying index may facilitate the more timely identification of new and differentiated markets, technologies and products. Figure 2: Potential for Earnings Growth Based on Consensus Analyst Earnings Estimates Consensus Analyst Estimated 3 5 Year EPS Growth (%) Figure 1: Overlap Analysis to the Select Sector SPDR Fund (XLK) FactSet Innovation ISE Cloud Computing ISE Cyber Security S&P 500 Growth Select Sector S&P 500 Estimated Earnings Per Share (EPS), which are based on analyst estimates, should not be construed as an indication of the current or future profitability of any investment product. Actual earnings per share may differ, even substantially, from that of estimated earnings per share. 4 0 % of FactSet Innovative Tech within XLK Lastly, the index is equal weighted to help reduce stockspecific risk. The equal weighting also allows for efficient use when pairing XITK with a broad-beta tech play that covers the entire sector, such as the Select Sector SPDR Fund (XLK), because overlap is reduced. As of December 18, 2015, of the 76 holdings in XLK, only 11 were also in the FactSet Innovative, which has a total of 85 securities. As shown in Figure 1, that s just a 13 percent of market cap overlap, and illustrates the value we see in adding an element of new tech to a portfolio. Finding Growth and Innovation Throughout Tech Number of Similar Holdings Data is as of the date indicated, is subject to change, and should not be relied upon as current thereafter. XITK s tracking index incorporates a wide array of innovative technologies, not just a single trendy pocket of IT, such as cloud computing or cyber security. Figure 2 shows a consensus of analyst estimates for projected earnings growth of the companies comprising the index relative to other tech-focused indices and broader market benchmarks, such as the S&P 500, as of December 18, In addition, based on the revenue mapping industry classification supplied by FactSet, the exposure to multiple trends such as cloud computing or cyber security is quite robust, allowing investors to harness these, as well as other innovative trends, within one product. As shown in Figure 3, XITK s index provides a less concentrated exposure to technology related firms, with only 12 percent of its holdings in the top 10 stocks. Meanwhile, this exposure is spread across a broad set of tech related specializations. Therefore, XITK s index not only offers exposure to one particular trend in the tech world, but may be able to systematically capture innovation throughout the sector. Figure 3: Concentration and Industry Breadth Analysis FactSet Innovation 41 6 ISE Cyber Security Percentage of Holdings in Top 10 (%) Number of Different Tech Related Sub-Industries 45 9 ISE Cloud Computing S&P 500 Information Sector Weights are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. State Street Global Advisors 2

3 Harnessing the Evolution of Sector and Industry Investing We believe that more than ever, sector-focused investing provides a better way to extract returns from the equity markets than focusing on size or style, while maintaining the ability to preserve portfolio diversification. Specific sectors may outperform or underperform during different parts of the economic cycle, and by using a sector-rotation strategy, investors can implement cyclical views in a much more refined way. 3 SGGA currently manages 30 US sector and industry ETFs with total assets of approximately $106 billion. 4 The SPDR FactSet Innovative ETF (XITK) is an innovative continuation of our long tradition of pioneering in the world of sector investing. Given our positive view on tech in 2016, XITK s bottom-up indexing methodology offers an attractive approach for a variety of investors looking to add a growth component to their portfolios. Potential Portfolio Implementation Sector Rotators For investors who favor tech as a growth play for a portfolio, there is the ability to carve out a portion of a broad sector beta exposure, offered through a vehicle such as the Select Sector SPDR Fund (XLK), and integrate XITK to stay focused on technology but with an added element of dynamic and disruptive innovation to harness potential growth. Thematic Investors Rather than focusing on one specific innovation trend within the sector, investors can drill into a wide array of cutting-edge tech. Leverage the unique bottom-up revenue mapping approach to capture evolving trends of firms that are innovating within niche areas of the tech sector. With the added growth screen, investors have some assurance that these firms are not on the wrong (late) side of the adoption curve. Definitions Alpha The excess returns of a fund relative to the return of a benchmark index. Beta Measures the volatility of a security or portfolio in relation to the market, usually as measured by the S&P 500. A beta of 1 indicates the security will move with the market. A beta of 1.3 means the security is expected to be 30 percent more than the market, while a beta of 0.8 means the security is expected to be 20 percent less volatile than the market. Earnings Per Share (EPS) A profitability measure that is calculated by dividing a company s net income by the number of shares outstanding. Electronic Media A sub-sector FactSet defines as including companies that produce media content in digital format and deliver, distribute and monetize their content via an electronic medium such as the Internet. Estimated 3-5 Year EPS Growth The estimated 3-5 year EPS growth is based on the underlying holdings of the index. The earnings estimates for the underlying holdings are provided by FactSet and are used to calculate a compounded annual growth rate for earnings per share over the next 3 to 5 years. These analysts estimates are forecasts of the firms potential ability to increase earnings per share over a full market cycle, and not a measure of expected stock or index price performance. The 3-5 year EPS estimate for an index is a market cap weighted average of the underlying firms figures. FactSet Innovative A benchmark to track the performance of specialized technology-related companies engaged in high-growth markets and industries. These companies are often involved in cuttingedge research, innovative product and service developments, disruptive business models, or a combination. ISE Cloud Computing Tracks companies actively engaged in a business activity supporting or utilizing the cloud computing space. ISE Cyber Security The companies in this index are either those which work to develop hardware and/or software that safeguards access to files, websites and networks, both locally and from external origins, or those that utilize these tools to provide consulting and/or cyber security services to their clients. Exchange Traded Fund (ETF) An ETF is an open-ended fund that provides exposure to an underlying investment, usually an index. Like an individual stock, an ETF trades on an exchange throughout the day. Industry A way of classifying a group of companies in terms of their main businesses. There are dozens of different industry classifications, which are typically grouped into larger categories called sectors. State Street Global Advisors 3

4 FactSet Revere The FactSet Revere Classification ( Hierarchy ) is a proprietary, U.S. patented sector and industry classification system built from the bottom-up, where the lowest hierarchical levels capture companies products and services. Sector An industry or market sharing common characteristics. Investors use sectors to place stocks and other investments into categories like technology, health care, energy, utilities and telecommunications. Each sector has unique characteristics and a different risk profile. S&P 500 A popular benchmark for US large-cap equities that includes 500 companies from leading industries and captures approximately 80 percent coverage of available market capitalization. S&P 500 Growth A benchmark that measures growth stocks using three factors: sales growth, the ratio of earnings change to price, and momentum. S&P Style Indices divide the complete market capitalization of each parent index into growth and value segments. Constituents are drawn from the S&P 500. S&P Select Sector Indices A benchmark that includes companies from the following industries: diversified financial services; insurance; commercial banks; capital markets; real estate investment trusts; thrift & mortgage finance; consumer finance; and real estate management & development. FactSet defines the sector to include Information Services providers, Hardware manufacturers, Software manufacturers, Electronic Components manufacturers, and Manufacturing Equipment and Services providers. Select Sector A sector benchmark that includes companies from the following industries: computers & peripherals; software; diversified telecommunication services; communications equipment; semiconductor & semiconductor equipment; internet software & services; IT services; wireless telecommunication services; electronic equipment & instruments; and office electronics. 1 Bloomberg, as of December 18, Bloomberg, SSGA as of December 18, Inside the Sector Vs. Style Comparison, SSGA Research, Oct Bloomberg, State Street Global Advisors, as of December 18, S&P 500 Information A benchmark comprised of companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS ) information technology sector. S&P Select Industry Indices The S&P Select Industry Indices are designed to measure the performance of narrower GICS industries within broader sectors and are based on the S&P Total Market, which has 3,886 constituents. These industry indices are equal weighted, which reduces stock specific risk and provides deeper market cap segmentation to large-, mid-, and small-cap firms. State Street Global Advisors 4

5 ssga.com spdrs.com For public use. State Street Global Advisors One Lincoln Street, Boston, MA T: Important Risk Information ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. Growth stocks may underperform stocks in other broad style categories (and the stock market as a whole) over any period of time and may shift in and out of favor with investors generally, sometimes rapidly. Non-diversified funds that focus on a relatively small number of issuers tend to be more volatile than diversified funds and the market as a whole. Passively managed funds hold a range of securities that, in the aggregate, approximates the full in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index. Concentrated investments in a particular sector or industry (technology sector and electronic media companies) tend to be more volatile than the overall market and increases risk that events negatively affecting such sectors or industries could reduce returns, potentially causing the value of the Fund s shares to decrease. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. Diversification does not ensure a profit or guarantee against loss. Past performance is not a guarantee of future results. The views expressed in this material are the views the SPDR ETFs and SSGA Funds Research Team through the period ended December 15, 2015, are subject to change based on market and other conditions and do not necessarily represent the views of State Street Global Advisors or any of its affiliates. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Standard & Poor s, S&P and SPDR are registered trademarks of Standard & Poor s Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation s financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index. Distributor: State Street Global Markets, LLC, member FINRA, SIPC, a wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., a registered broker-dealer, is distributor for SPDR S&P 500 SPDR S&P MidCap 400 and SPDR Dow Jones Industrial Average, and all unit investment trusts. ALPS Portfolio Solutions Distributor, Inc. is distributor for Select Sector SPDRs. ALPS Distributors, Inc. and ALPS Portfolio Solutions Distributor, Inc. are not affiliated with State Street Global Markets, LLC. Before investing, consider the funds investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus which contains this and other information, call or visit spdrs.com. Read it carefully. Not FDIC Insured No Bank Guarantee May Lose Value 2016 State Street Corporation. All Rights Reserved. ID5616-IBG Exp. Date: 12/31/2016 SSL000645