Betting On Consumer ETFs

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Since Oct. 4, 2011, U.S. equities have pushed sharply higher, Tuesday's bath notwithstanding.

If a rallying market signals an expanding economy, consumer cyclical sector ETFs should be the train to ride. There's only one problem. This time the recovery lacks the key driver for consumer cyclicals to take off, namely paychecks.

This may explain why consumer cyclicals have barely beaten broad equities since Oct. 4.

As a proxy for the segment, I chose the largest consumer cyclical ETFs by assets:the Consumer Discretionary Select Sector SPDR Fund (NYSEArca:XLY).

To represent the broad U.S. equity market, I used the SPDR S&P 500 (NYSEArca:SPY).

With returns of 25.5 percent, XLY beat SPY, but not by much. SPY jumped an impressive 23.4 percent during that same period, from Oct. 4 through March 1.

What's more, four other sectors beat consumer cyclical stocks during the same period. I used other SPDR sector ETFs as proxies.

Big inflows into these funds suggest that smart money thinks the sector is primed to take off. But why?

Maybe investors are looking for returns from something other than Apple. The tech juggernaut delivered an incredible 46 percent total return from Oct. 4 to March 1. But if you own the S&P 500, you've already got 4 percent in Apple stock and perhaps want to look for another growth engine.

Or maybe the investors behind the net flows into consumer cyclicals think that honest-to-goodness hiring and wage growth are near at hand, and with it, more discretionary spending.

Or, perhaps they think that, at minimum, U.S. consumers-feeling more confident, if not truly richer-will release pent-up demand after keeping their wallets closed over the past three or four years.

Contenders

The four largest funds in the consumer cyclical sector hold what they call either "consumer discretionary" stocks or "consumer services" stocks. While stocks in these groups certainly overlap, large differences exist right at the top of the holdings list.

For example, XLY, a consumer discretionary fund, holds Ford Motor Co. But the iShares Dow Jones U.S. Consumer Services Index Fund (NYSEArca:IYC) doesn't. It holds Walmart instead.

Differing stock universes aside, the funds' selection and weighting processes play a huge role too. The second-largest consumer cyclicals fund by assets is First Trust's Consumer discretionary AlphaDex Fund (NYSEArca:FXD), which selects and weights stocks with a multifactor model rather than the usual cap-weighted approach.

These differences in the stock universe and in selection and weighting processes help explain some of the performance discrepancies.

Performance

Here's a peek at the performance of these same four-largest consumer cyclicals funds in the 12 months ended March 1.

As it happens, a three-year look-back coincides closely with the bottom point of the broad market following the financial crisis.

FXD has screamed back from this low point, albeit with a wild ride along the way. That's consistent with the idea that FXD has higher beta than its peers.

Conversely, both charts suggest IYC has lower beta than other sector funds.

To be clear, I expect all four of these consumer cyclical funds to have higher beta than SPY. The point is that each fund parks itself on a different part of the risk/return spectrum.

These funds diverge on fees as well, with FXD charging the most by far at 0.70 percent and IYC next highest at 0.47 percent. XLY and VCR are far cheaper at 0.18 percent and 0.19 percent, respectively.

So, if you're inclined to follow the money, or if you believe the economy really is growing and don't want more Apple in your cart, consumer cyclical ETFs offer a viable alternative.

Of the four funds I touched on here, I happen to like XLY for its low cost and middle-of-the-road risk level, relatively speaking. For a list of all eight funds in the sector, use our IndexUniverse ECS fund finder.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: FXD , IYC , SPY , VCR , XLY

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