The U.S. is the world's largest aerospace and defense market.
The growth of this sector is heavily tied to the spending outlook
of the government. This year, Congress has passed the defense
authorization bill for $662 billion which mainly comprises $529.6
billion for core spending. The bill also includes a provision of
$115.5 billion for the wars in Afghanistan and Iraq and $16.9
billion for the Department of Energy's defense programs.
The U.S. alone accounts for 40% of total global spending on
defense. But with the U.S. government deciding to pare the defense
budget, and with drawdown of troops from Afghanistan and Iraq,
major defense companies now have to scout for more business from
overseas destinations instead (read
Three ETFs For An Iranian Crisis
In this difficult scenario of tight budgets and cuts to big
programs, acquisitions offer big defense companies with strong
financials to bolster their positions. The U.S. Defense department
also supports mergers among the defense companies except for the
top group of suppliers acquiring each other.
Strategic alliances among companies have been on the rise. The
defense operators at times join forces with each other, bring along
their individual expertise in the table and work as a cohesive unit
for big defense deals.
Additionally, big international orders will also add to the
growth of the defense companies especially when the U.S. government
is taking proactive steps to trim the defense budget. One of the
noticeable international orders in the recent past has been Japan
Ministry of Defense's choosing Lockheed's F-35 Lightning II as
Japan Air Self Defense Force's next generation fighter
The Boeing Company
) received an order from the Kingdom of Saudi Arabia for 84 new
F-15 fighter aircrafts and to upgrade 70 existing F-15s. Besides,
Boeing also received orders for 70 new AH-64 Apache strike
helicopters and 36 AH-6i helicopters, plus support and training.
This slew of orders would boost Boeing's top line by $24
At the macro level, a gradual shift in defense spending patterns
can be discerned. In response to asymmetric terrorist threats, the
emphasis appears to have shifted to high-tech intelligence
equipment, replacing demand for conventional big guns and heavy
armor. The major industry players have, in response, resorted to
bolt-on acquisitions to plug gaps in their product offerings.
Continuous technology upgrades are imperative, in specialized
niches like aerospace and defense, to meet the complex and varied
needs of customers. Among the state-of-the-art products, the latest
radar and telecommunication systems, new ballistic missiles,
unmanned warplanes, development of fighter jets, and sophisticated
surveillance equipment have been most in demand worldwide (read
Three Great Tech ETFs That Avoid Apple
Also, Asian countries are keen on increasing their defense
budget although not in the same capacity as U.S. and European
countries. China has been focused on strengthening its defense
capability and has accordingly bolstered its budget. India also
plans to spend $80 billion in a span of five years in order to
build up their defense force as well.
However, the global downturn has certainly impacted the
Aerospace and Defense industry as many countries were compelled to
cut their defense expenses. Instead of defense spending, many of
the biggest spenders are gradually lowering their defense budgets
and concentrating on other avenues to fix their ailing economy (see
more on ETFs at the
A similar situation is happening at home at well as speculation
is beginning to build over a plan to reduce the defense budget by
$100 billion over the next five years. These cutbacks will impact
the big contractors as the lion's share of their revenues comes
from domestic defense spending.
Meanwhile, the United Kingdom is likewise planning to slash its
defense budget by 20% while Italy, thanks to its own budget woes,
has decided to follow a similar path. There is also pressure on
France, Germany and Spain to review and trim their defense spending
for similar reasons as well.
Additionally, Obama's decision to delay the funding of many
projects led to the termination of many projects. Accordingly,
after assessing the current and future market potential, Boeing
decided to shut down its Boeing Defense, Space & Security
facility in Wichita by the end of 2013.
Improvement in the exchange-traded fund industry has showed the
path for the building of products inclined towards the aerospace
& defense industry. Investors seeking to play on this slice of
the market should look for ETFs like XAR, PPA and ITA.
If the companies continue to book new orders, these funds could
get a nice boost. However, if recent market turbulence causes
governments to cut back their defense budgets further, then these
funds could be in trouble.
Dow Jones U.S. Aerospace & Defense Index Fund (
The iShares Dow Jones U.S. Aerospace & Defense Index Fund is
the most popular ETF in the aerospace and defense industry and is
linked to the Dow Jones U.S. Select Aerospace & Defense Index.
The fund has the highest AUM in the aerospace and defense ETF space
of $66.95 million.
The fund seeks to invest in 34 holdings giving the product a
58.8% concentration in the top ten securities.
United Technologies Corp. (
The Boeing Company (BA)
Precision Castparts Corp. (
occupy the top three positions with 9.4%, 8.71%, and 6.40% of
assets invested, respectively. Among the sectors, Aerospace has
been the top priority of the fund representing a 58.46% of the
Defense has been the second preference with 41.43% of
investment. The fund has delivered a return of 5.65% over a period
of one year and charges an expense ratio of 47 basis points from
Mid Cap ETF Investing 101
Power Shares Aerospace & Defense Portfolio (
Another popular ETF targeting the aerospace and defense industry
is the Power Shares Aerospace & Defense Portfolio which is
linked to the SPADE Defense Index. The Index is designed to
identify a group of companies involved in the development,
manufacturing, operations and support of U.S. defense, homeland
security and aerospace operations.
The fund seeks to invest its $20.02 million asset base in 51
stocks, more than what ITA holds. Although the fund appears to be
heavily invested in the top 10 holdings; the percentage holding in
top 10 is still less than ITA. The fund invests 49.79% of its
assets in the top 10 holdings.
The Boeing Company (BA)
occupies the top position in the fund while
United Technologies Corp. (UTX)
is in third. The second position has been occupied by Honeywell
International Inc. (
). Among sectors, the fund concentrates more on industrials with
80.32% of investment made in it.
In spite of the attractive holding pattern, the fund delivered a
negative return of 0.06% over a period of one year compared to the
positive return delivered by ITA. The fund is also more expensive
than ITA charging 66 basis points per year.
SPDR S&P Aerospace & Defense ETF (
Launched in September 2011, The SPDR S&P Aerospace &
Defense ETF is the most recent addition in the aerospace &
defense ETF world. It seeks to replicate as closely as possible,
before expenses, the total return performance of the S&P
Aerospace & Defense Select Industry Index, a benchmark that
tracks a group of companies involved in the development,
manufacturing, operations and support of U.S. defense, homeland
security, and aerospace operations (see the
Comprehensive Guide to Utility ETF Investing
The fund seeks to invest its total asset base of $15.35 million
in 35 stocks. However, the fund appears to be somewhat concentrated
in the top 10 holdings as it invests 45.19% of its assets in the
top 10 companies. Among the sectors, the fund appears to be more
concentrated in industrials with 93.19% of the investment going to
The rest has been assigned to Technology and Consumer cyclical.
TransDigm Group Incorporated (
, Hexcel Corp and
L-3 Communications Holdings Inc. (
occupy the top 3 positions in the fund. Since inception, the fund
has delivered a return of 23.58% and charges investors 35 basis
points in the form of fees for investment made in it, the lowest
among the three ETFs in the space.
Overall Outlook for Defense ETFs
The U.S. is the leader in global defense spending. The country
is not only a major superpower, but it has strategic alliances in
place with other foreign nations with major military strengths and
geopolitical concerns as well. The country sometimes shares its
military technology and supplies sophisticated weapons to its
These activities in turn boost the revenue of the defense
operators. The industry has been performing well at times of
global recession compared to other industries, so investors seeking
better diversification should consider including ETFs targeting the
aerospace & defense industry in the portfolio.
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