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ETFs reveal a struggling tech sector

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ETFs reveal a struggling tech sector

For the tech sector, 2016 has had its challenges.

The SNL Kagan New Media Index has added less than 1% during theyear. Meanwhile, the SNL Kagan Communications Index has jumped 18.3% and the S&P500 has added about 5.9%.

In fact, after attracting plenty of investment activity in 2013and 2014, interest in publicly traded technology companies seemed to waiver in 2015and deteriorate further in 2016.  While talkof bubbles has moderated in the past 12 months, the equity markets are still troubledfor technology companies.

The number of IPOs in the sector hit recession-era in 2016. Among the IPOs thatdid close recently, many like SquareInc. struggled to show returns for investors. In the private markets,down rounds of debt financing become increasingly common as investors cut valuationson even some of the biggest names in the Silicon Valley, Snapchat and Dropbox included.

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The trend is apparent looking at various exchange traded fundscovered by S&P Global Market Intelligence. This year has seen more investmentdollars being pulled from technology-focused ETFs than added, by far, though theoutlook appears to have improved somewhat at the end of the half. The total sumof all the net flows in and out of technology ETFs in the first half of 2016 cameto negative $4.98 billion, meaning across all 36 funds tracked by S&P Global,investors pulled out almost $5 billion. The largest fund, the Technology SelectSector SPDR Fund, or XLK, is consistent with the trend. It has about $12.06 billionunder management after investors pulled $1.51 billion out during the year throughJune.

The next largest fund, the Vanguard Information Technology IndexFund, or VGT, actually showed net investment gains for the year, if only modestly.For the first half of 2016, that ETF saw net inflows of $58.1 million.

But where the XLK saw its prospects change for the better inJune, with positive inflows of $22.9 million tempering losses through the priorfive months, the VGT saw June cut its prior 2016 inflows by more than half, shedding$87.3 million in funds during the month.

Meanwhile, the XLK has shown some of the best performance amongtechnology ETFs for the year to mid-July, delivering a 5.6% total return. Only twoother funds recorded greater gains.

The VGT, meanwhile, recorded a gain of 3.1%. However, none ofthe tech-focused funds beat the 7.0% total return investors could have collectedby just following the S&P 500, further illustrating the weakness in the techsector at present.

The XLK includes communications names like Verizon Communications Inc. and AT&T Inc., on top of S&P 500 tech companies likeApple Inc., and The fund benefited from thesupport of traditionally nontech companies like Verizon and AT&T as the communicationssector strongly outperformed in 2016. Shares of Verizon and AT&T have both gainedover 20% year-to-date.

VGT, on the other hand, only includes technology companies, andit includes smaller names like PandoraMedia Inc. and ZillowGroup Inc.

Prospects, however, might change for the biggest tech ETFs, whichcould signal a turnaround for investment in the sector broadly. S&P CapitalIQ recommends "overweight" ratings on both the XLK and the VGT.

Also, out-flows are moderating. In June and the first half ofJuly, gross net flows for the 36 ETFs covered by S&P Global were both negative,but at $102.6 million and just $1.0 million, respectively, they represent much lessnegative movement than in the prior five months of 2016. XLK actually posted positiveinflows in June, collecting an extra $22.9 million.

There are other signs of strength elsewhere among tech funds.For example, Blackrock's iShares North American Tech-Software ETF, or IGV, added$74.3 million in June and another $9.4 million in the first two weeks of July.

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