The global aerospace and defense industry is showing remarkable
improvements this year thanks to rising demand for commercial and
military activities, and technological innovations. This comes
despite the biggest consumer of defense equipment, the U.S.
government, possibly taking an axe to their broad spending in the
near future, potentially derailing growth in this corner of the
market going forward.
This trend is further continued across the globe in a number of
other key markets. However, the issue always flows back to the U.S.
as America accounts for nearly half of total military spending in
the world, easily outpacing the next five biggest spenders combined
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Defense Budget Cuts: Reason for Worry?
Due to this trend, the Department of Defense (DoD) has proposed
a base budget of $525.4 billion for fiscal 2013 with $88.5 billion
for overseas operations spending, primarily in Afghanistan. The
proposed budget is less than the $531 billion base budget and $115
billion for overseas operations approved for fiscal 2012.
Additionally, the U.S. military is facing budget cuts of $500
billion over the next decade (2012-2021), including $55 billion for
2013, if Congress fails to find proper ways to reduce $1.2 trillion
of fiscal deficits before the end of December. So investors and
market participants could see a huge drop off in spending in the
coming years, especially if forays into other nations are curtailed
and troops are removed from the broader Middle East and South Asia
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The spending cuts will certainly impact big contractors, as the
lion's share of their revenues comes from domestic defense
spending. The cutbacks would not only harm major contractors, but
will likely trickle down into the job market as well with a great
deal of layoffs across the nation.
However, these cuts are by no means guaranteed, especially given
the numerous geopolitical risks across the globe. Additionally, a
number of new emerging markets as well as developed nations, such
as India, China, Japan, the United Arab Emirates, Saudi Arabia, and
Brazil are boosting defense spending.
Some of these new markets could help ease the pain for major
defense contractors and assist them in producing at a high level
despite a decline in spending from the top market for defense goods
in the world (read:
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Further, cyber security offers a new window of opportunity with
both government and private players seeking ways to safeguard
against online attacks. Increasing awareness of cyber threats could
open up new markets for the defense majors despite lower demand for
big ticket items like jets and tanks.
How to Play Defense Stocks
Investors seeking to play the defense market but are still
worried about budget cuts, may be better served with an ETF
approach. Currently there are three ETFs that target the defense
and aerospace market, each of which we have highlighted in greater
detail below: (See more ETFs in the
iShares Dow Jones U.S. Aerospace & Defense Index Fund
Investors seeking exposure to the U.S. Aerospace & Defense
market may find ITA an intriguing choice. The fund seeks to
replicate the price and yield of the Dow Jones U.S. Select
Aerospace & Defense Index, before fees and expense.
With holdings of 33 stocks, the product consists of
manufacturers, assemblers and distributors of aircraft and aircraft
parts in the aerospace as well as producers of components and
equipment for the defense industry, such as military aircraft,
radar equipment and weapons.
The fund does just an average job in spreading assets across
individual securities, as it puts about 59% of focus on the top 10
firms. United Technologies (
), Boeing Co. (
) and Lockheed Martin (
) make up more than 24% of the combined share in the basket. While
the product is tilted towards the large caps with more than 50% of
the exposure, mid and small caps take up the remaining portion of
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From a sector look, aerospace has been the top priority of the
fund representing 55% of the total assets, followed by defense with
a 45% share. The product so far has managed assets of $89.8 million
and was launched on May 2006.
The fund trades in a small volume of roughly 7,000 shares per
day, suggesting wide bid/ask spread beyond the expense ratio of
0.47% per year. Despite its illiquid nature, the fund has delivered
impressive returns of about 6% year-to-date (as of August 31) and
yields 0.94% annually. Such returns are much more than the total
expense, making it a decent play on the space.
PowerShares Aerospace & Defense Portfolio (
Launched in October 2005, PPA matches the performance of the
SPADE Defense Index. The stocks considered in the fund are the
companies engaged in the development, manufacturing, operations and
support of U.S. defense, homeland security and aerospace
The products seeks to invest about 50% of its assets in the top
10 holdings, with Honeywell International (
), United Technologies and Boeing Co taking up the top three spots
in the basket. This allocation is arguably better than ITA and the
fund holds a total of 50 securities in the portfolio, which has a
nice mix of different asset classes. Large caps accounted for 45%
share while mid and small caps accounted for 35% and 20%,
Unlike ITA, the product does not only include securities from
the aerospace and defense sectors, but also contains technology and
material companies, with 17% and 4% share, respectively (read:
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With AUM of $47.9 million, PPA has been the best performer in
the aerospace and defense sector so far in the year, returning more
than 9% (as of August 31) and yielding 1.14% annually. Although the
returns are encouraging, the fund charges 66 bps in fees per year
from investors, which is higher than its iShares counterpart. The
fund is more liquid than ITA, trading in volumes of 10,000 shares
per day on average.
SPDR S&P Aerospace & Defense ETF (
This fund is the new entrant into the aerospace and defense
space, making its debut in September 2011. It tracks the S&P
Aerospace & Defense Select Industry Index, a subset of S&P
Total Stock Market Index.
Like ITA, the product invests all of its assets in the aerospace
and defense industry with large concentration (45%) in the top 10
holdings. Northrop Grumman Corp (NOC), Spirit Aerosystems Holdings
(SPR) and Lockheed Martin occupy the top positions in the basket
with a combined 14% share.
Nevertheless, the product has a nice mix of portfolio with 36
securities. While large caps comprise about 40% of the assets, mid
and small caps account for 35% and 25%, respectively.
This ETF is the low cost choice in the aerospace and defense
space, charging only 35 bps in annual fees from investors. However,
the product has a relatively higher bid/ask spread thanks to the
paltry average daily volume of 2,000 shares. With total assets of
$14.9 million, the fund has delivered an excellent return of 7% so
far in the year and yields 0.55% of dividend per annum (read:
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Provided below is the summary of the three ETFs:
AUM (in millions)
No. of Holdings
% of Assets In Top 10 Holdings
YTD Return (as of August 31, 2012)
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BOEING CO (BA): Free Stock Analysis Report
ISHARS-DJ AEROS (ITA): ETF Research Reports
PWRSH-AERO&DEF (PPA): ETF Research Reports
SARATOGA INVEST (SAR): Free Stock Analysis
UTD TECHS CORP (UTX): Free Stock Analysis
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