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Inside the Top Zacks ETF Ranked Technology Fund

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Technology is the most powerful industry influencing the overall health of the U.S. economy. The ongoing boom in this important sector is driven by Internet services, in particular mobile Internet, and it doesn't appear to be slowing down anytime soon.

As the digital age dawns on us, the demand for mobile Internet is rising rapidly with the growing popularity of Intranet and Virtual Private Networks (VPNs), online video streaming, video conferencing, IPTV, managed telepresence, cloud computing and network security (read: Inside The Cloud Computing ETF (SKYY)).

Over the last few years, Internet has taken the most vital place in a technology-driven world, surging more than double each year. The growing demand for Internet connected devices such as smartphones, tablets, notebooks, iPhones, and laptops are boosting data traffic. The global mobile data traffic is expected to grow eighteen folds by 2016, as per a recent study from the networking company Cisco Systems (CSCO).

Thanks to modern technology and recent developments, investors have begun to show interest in the Internet sector. For investors seeking to play this space, our research suggests that the PowerShares NASDAQ Internet Portfolio Fund (PNQI - Free Report) could be an interesting choice. The fund currently has a Zacks #2 Rank (Buy), and thus we expect it to outperform its peers in the high-risk tolerance bracket.

PNQI: A Solid Choice in the Tech Space

Launched in June 2008, the fund has emerged as a strong winner in the tech space, producing more than 26% of an annualized return over the past three years. The product seeks to match the price and yield of the NASDAQ Internet Index, before fees and expenses.

With holdings of 69 securities, PNQI includes the largest and most liquid U.S.-listed companies engaged in Internet-related businesses that are listed on one of the major U.S. stock exchanges (read: Three Great Tech ETFs That Avoid Apple).

The fund allocates about half of the assets to large cap firms, which tend to be more stable and less volatile than the mid and small counterparts. Mid and small caps accounted for the rest of the basket. More than two-thirds of the fund’s portfolio has a growth style, which means the securities in the fund target the growing segment of the market.

The growth fund arguably offers above-average revenue and earnings growth with high price-to-equity (P/E) and price-to-book (P/B) ratios but yield lower than the value and blend counterparts. The ETF has a P/E ratio of 27.23 and P/B ratio of 3.50.

Growth funds also increase more than the other funds in bull markets, although they also fall more drastically in bearish times. Since many are looking for a modest recovery, growth funds seem like a decent choice for those expecting a return to market health in the fourth quarter (read: Five Best Performing ETFs (So Far) in 2012).

PNQI has been able to manage assets of $49.6 million, returning more than 15% year-to-date (as of August 31). In fact, this return is higher than the returns from the S&P 500 by 350 bps.

The product is often considered a high momentum (the change in the fund’s price over the past three months) ETF with value closer to 109, suggesting that it will continue to move higher relative to the other counterparts (read: Do You Need a High Momentum ETF?).

Further, the ETF has very little correlation with the S&P 500, as indicated by R-Squared of 29.06%. It is constantly outperforming its benchmark index, as depicted by positive alpha.

PNQI: A focused product

The ETF is expensive in the technology space, charging 60 bps in annual fees from investors. In fact, its expense ratio is more than triple the Technology Select Sector SPDR ETF (XLK - Free Report) , which is the most popular and the low cost choice in the space (read: Three Technology ETFs Outperforming XLK).

Though PNQI contains liquid securities in its portfolio, it trades in low volumes of 13,000 shares per day. This suggests that an extra cost might be involved in the form of bid/ask spread at the time of trading.

The fund is not widely spread across individual securities, as it puts around 62% of its assets in the top 10 holdings (read: Create a Diversified Portfolio Using ETFs). eBay, Google and Amazon hold the top three positions in the basket and combined make up for 27% share. This suggests that company-specific risk is high in the case of PNQI and the top 10 holdings dominate the returns of the fund.

From a sector perspective, information technology takes the top spot in the basket with 74% share, followed by consumer discretionary (25%), telecommunication services (0.6%) and financials (0.5%). The product has a higher concentration risk of roughly 20%, indicating its heavy reliance on a particular sector or security.

In addition, the fund is widely exposed to the U.S. (81%) followed by Chile (13%), the Netherlands (3%), Argentina (2%) and Canada (2%). This suggests that not only is the fund a potential outperformer in the tech space, but it is also a good pick for investors seeking to zero in on a high growth segment  while concentrating exposure on some of the safest nations around the globe.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings; Low, Medium, or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

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