Narrow Based ETFs

IndexUniverse has a useful post up that compares the PowerShares Aerospace & Defense Portfolio (PPA) and iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA). Obviously the two cover a lot of the same ground and perform very similarly to each other.

I have been a big believer of keeping a defense stock (or if you prefer, an ETF) in the portfolio as something that might go up in the face of certain types of external shocks. The article spells out some of the macro factors that make the space compelling as well, at least I find it compelling anyway.

This is a pretty good example to support the case to go narrower than broad based index funds. In an equity portfolio with four or five broad based equity funds there is very little chance of creating any sort of zigzag effect in the portfolio. In the case of four broad funds you really have four funds that will move in the same direction but in different magnitudes and probably with different volatility characteristics. So they represent different market segments, broadly speaking, but the actual diversification is not that effective.

In the face of certain external shocks gold and defense stocks have a pretty good chance of going up. This effect cannot be created with a combo of SPY, IWM and EFA.

For anyone interested in going narrower in their portfolio construction and including defense stocks they either need to buy one of these ETFs or buy an individual stock. We have a bigger cap defense stock instead of an ETF and at times it outperforms the ETFs and other times it lags but really there hasn’t been much difference in the price movement but the stock pays a pretty good dividend, more than the trailing yields on the ETFs.

Defense stocks are obviously part of the industrial sector. In building that sector within a portfolio there are themed funds to use like PPA and ITA, there are relatively broad based funds like Industrial Sector SPDR (XLI) that will be heavy in things like General Electric (GE) and 3M and maybe a country fund can fit the bill.

I’m not sure off the top whether or not there are any country funds that are very heavy in industrial stocks but other examples could be iShares Taiwan (EWT) which is 50% tech or iShares Peru (EPU) which is 65% materials. And of course now we have sector/country funds those being the Chinese sector funds from GlobalX. To be clear there are a lot of different theme funds that are heavy in industrial stocks that could be used for exposure to that sector.

Figuring out the exposures provided is as simple as going to the website of the fund provider and looking at the sector make up. I would not take a short cut here and make assumptions because sometimes they are not as they appear. For example while EPU is a proxy for materials the GlobalX Colombia Fund is heaviest, by far, in financial stocks. Another example is the wind and solar ETFs which are primarily the industrial companies that make the equipment so not an energy proxy.

Sadly, Jason Bay is no longer on the Red Sox, he signed with the Mets. I was hoping that because Bay puts up big numbers without being a loudmouthed idiot that they would figure a way to make it work.

3 Comments

  1. I hold a little GLD for portfolio insurance and, in the short run (one year,) it correlates pretty well with the defense etfs that you mention (0.74 with PPA and 0.72with ITA.) Over three years, it’s interesting that the correlations actually turn quite negative (-0.43 with PPA and -0.40 with ITA.)

    I suspect there are more and differrent external factors that influence GLD than the defense etfs, which may actually add some zigzag effect to the portfolio. I’m a little surprised.

    Reply
  2. my hope for defense stocks is zigzag during a shock not over several years.

    Reply
  3. With what seems to be a growing murmur of discontent, blowing in the winds of an approaching 2010, I have made a conservative (and hopefully intelligent) decision, Roger, and changed an ETF (gold miner) that has done exceedingly well this last year to one which is very cash-heavy (65%). What equity exposure it has includes some (less than 5% I think) ability to short sectors, depending on the manager’s perspective.

    I still have a similar ETF (commodities companies) and so am only reducing my weight here. It is the first major change I’ve made in almost 2 years!! But, a much more informed one, thanks to a lot of reading. *Tips Hat*

    Have a great New Year’s Eve!

    Reply

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Narrow Based ETFs

IndexUniverse has a useful post up that compares the PowerShares Aerospace & Defense Portfolio (PPA) and iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA). Obviously the two cover a lot of the same ground and perform very similarly to each other.

I have been a big believer of keeping a defense stock (or if you prefer, an ETF) in the portfolio as something that might go up in the face of certain types of external shocks. The article spells out some of the macro factors that make the space compelling as well, at least I find it compelling anyway.

This is a pretty good example to support the case to go narrower than broad based index funds. In an equity portfolio with four or five broad based equity funds there is very little chance of creating any sort of zigzag effect in the portfolio. In the case of four broad funds you really have four funds that will move in the same direction but in different magnitudes and probably with different volatility characteristics. So they represent different market segments, broadly speaking, but the actual diversification is not that effective.

In the face of certain external shocks gold and defense stocks have a pretty good chance of going up. This effect cannot be created with a combo of SPY, IWM and EFA.

For anyone interested in going narrower in their portfolio construction and including defense stocks they either need to buy one of these ETFs or buy an individual stock. We have a bigger cap defense stock instead of an ETF and at times it outperforms the ETFs and other times it lags but really there hasn’t been much difference in the price movement but the stock pays a pretty good dividend, more than the trailing yields on the ETFs.

Defense stocks are obviously part of the industrial sector. In building that sector within a portfolio there are themed funds to use like PPA and ITA, there are relatively broad based funds like Industrial Sector SPDR (XLI) that will be heavy in things like General Electric (GE) and 3M and maybe a country fund can fit the bill.

I’m not sure off the top whether or not there are any country funds that are very heavy in industrial stocks but other examples could be iShares Taiwan (EWT) which is 50% tech or iShares Peru (EPU) which is 65% materials. And of course now we have sector/country funds those being the Chinese sector funds from GlobalX. To be clear there are a lot of different theme funds that are heavy in industrial stocks that could be used for exposure to that sector.

Figuring out the exposures provided is as simple as going to the website of the fund provider and looking at the sector make up. I would not take a short cut here and make assumptions because sometimes they are not as they appear. For example while EPU is a proxy for materials the GlobalX Colombia Fund is heaviest, by far, in financial stocks. Another example is the wind and solar ETFs which are primarily the industrial companies that make the equipment so not an energy proxy.

Sadly, Jason Bay is no longer on the Red Sox, he signed with the Mets. I was hoping that because Bay puts up big numbers without being a loudmouthed idiot that they would figure a way to make it work.

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