ETFs Are Supposed to Make Complex Ideas Simple. Here's What You Need to Know About This One Before You Buy.

The Invesco Building & Construction ETF is meant for investors with a little more experience, but it requires some digging to understand it.

The entire concept behind exchange-traded funds (ETFs) is to make investing easier. With one investment you can buy large numbers of stocks and bonds, instantly creating a diversified portfolio. But Wall Street has taken ETFs well beyond their original conception, and the Invesco Building & Construction ETF (PKB -0.75%) is a good example of making simple things more complex.

The Invesco Building & Construction ETF’s name is accurate, but…

The first exchange-traded fund ever created was designed to track the S&P 500 index. Given that the S&P is generally considered “the market,” it was a great way for investors to very simply get exposure to equities. There was a mad rush on Wall Street to bring out more index-tracking ETFs once it became clear that the ETF concept would work.

A construction worker leaning against a wall with people in the background looking at blueprints.

Image source: Getty Images.

The problem is that there are only just so many well-known indexes. So the next step was to cut up the indexes. For example, you can buy each of the 11 individual sectors within the S&P 500 via Sector Select SPDR ETFs. But that’s not the only way to slice and dice the market, and soon Wall Street was launching factor funds. These investment options broke indexes down by things like value and growth. As you might expect, you can buy an S&P 500 growth ETF and an S&P 500 value ETF. Other factors have been brought in as well, such as dividend yield and dividend growth, among many other things.

And now you can buy ETFs that mix sector investing with factor investing, just to keep you on your toes. That’s exactly what the Invesco Building & Construction ETF does (and more, keep reading). As the Invesco Building & Construction ETF’s name clearly implies, it is designed to provide investors with broad exposure to the building and construction sectors, if that’s what you are looking for.

But the index takes into account a unique “methodology” that evaluates companies on a quarterly basis based on “price momentum, earnings momentum, quality, management action, and value.” Across all of these broad categories there are 47 different metrics that get evaluated. The basic goal is to pick the best stocks within the building and construction sector. That’s well and good, but as an investor it will be impossible for you to really know why the ETF has selected any individual stock.

The Invesco Building & Construction ETF goes one step further

So far the logic here, while complex, makes a lot of sense. Who wouldn’t want to buy the best stocks from a sector they like? But the Wall Street alchemy doesn’t stop there. The Invesco Building & Construction ETF also takes a unique approach to the weighting of the stocks in the portfolio.

The universe of possible stocks is broken down into larger and smaller companies. Eight of the best-ranked large companies are put into the fund with a total weighting of 40%. Each stock gets about 5% of assets. The remaining 60% of the portfolio’s assets goes into 22 or so smaller companies, each getting a little under 3% of assets allocated to them. That’s the broad weighting methodology, which can be adjusted a little based on the unique circumstances of each sector that Invesco covers. The basic idea is to ensure that performance isn’t solely driven by the largest stocks in a sector.

All of this extra work increases the expense ratio of the ETF, which sits at around 0.62%. That’s pretty high for an ETF, considering that the SPDR S&P 500 ETF has an expense ratio of just 0.09%. Some ETFs have even lower expense ratios. So you are paying up for Invesco’s complex machinations.

More than meets the eye

Is the Invesco Building & Construction ETF a good ETF to buy? That depends. You need to be looking for very specific investment exposure and you need to understand that you aren’t buying a simple index. The Invesco Building & Construction ETF is layering in a lot of additional information when it selects stocks for the portfolio and it doesn’t have a simple weighting approach. In other words, the Invesco Building & Construction ETF has made the ETF concept a lot more complicated and it just isn’t as simple as “now you have exposure to building and construction companies.”

Invesco has a collection of similarly constructed sector ETFs. They may be perfect for you, but you had better make sure you understand what these ETFs are doing before you buy one.

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