The U.S. is home to the world's largest aerospace and defense
market and also has the world's largest military budget. The
industry is mainly dependent on U.S. government contracts which
also imply that defense spending by the government largely
decides the outlook for the industry, which isn't good news given
the latest talk of budget cuts (
Defense ETF Investing 101
Currently, U.S. defense spending is negatively impacted by the
Budget Control Act of 2011. On Jan 1, 2013, the House partially
averted the fiscal cliff and delayed spending cuts or
sequestration by two months.
The two-month breather is finally coming to an end and the
U.S. defense industry has little hope of averting the
consequences. The sequester is expected to kick in on Mar 1, 2013
and could greatly impact the defense industry.
The sequestration cuts mandated by the Aug 2011 debt-limit
deal includes a $500 billion cut in spending (over 10 years) on
top of the $487 billion which has already being cut by the Obama
administration from defense spending over the same time period (
Any hope for Aerospace and Defense Industry ETFs
Although the immediate impact of the sequester was postponed
for some time yet it looms large on the defense industry. Along
with the Pentagon cut of $500 billion spread over 10 years,
sequestration is also inclusive of domestic discretionary
spending cut of the same amount.
Recently back President Obama made an effort to rescue the
defense industry from the adverse effects of sequestration. His
plan included an arrangement that would lead to both tax
increases and spending cuts. If enforced it would have led to $21
billion less in defense spending cut for this fiscal year and
roughly $250 billion less through fiscal 2022.
Impact of Sequester on U.S. Military
The sequester would result in the U.S. military having to cut
its work force, and restrain training and maintenance of existing
forces. Many big budget and high tech defense programs look to be
on the chopping block as well, so the cuts could stretch across
Impact of Sequester on Defense Companies
The cuts could also have an adverse effect on the companies
within the defense industry. The bottom line of many companies
will be negatively affected. Ultimately the prices of many
defense stocks will tend to fall.
The fear of the spending cut can already be seen in defense
Lockheed Martin (
. The company reported a decline in net profit for the fourth
quarter of 2012. Lockheed Martin was compelled to slow the
pace of its production and also lay off hundreds of employees
when the U.S. government cut the number of F-35 jet fighters it
plans to buy (
Can The Defense ETFs Soar Despite Headwinds?
It should be noted that though the sequestration will test the
large defense contractors sourly, the smaller companies are the
ones to be the worst hit. Smaller companies that frame the
industry's supply chain would be severely impacted, as they are
less diversified than many of their large cap counterparts.
Given this backdrop, investors may opt to avoid investing in
that provide exposure to the U.S. defense companies. Below we
have highlighted a few of the ETFs that track the U.S. defense
companies and could be in for a wild ride ahead:
iShares Dow Jones U.S. Aerospace & Defense Index
With holdings of 33 stocks, ITA 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 (
Zacks #1 Ranked Aerospace & Defense ETF in
The fund puts about 53.96% of its focus on the top 10 firms.
United Technologies, Boeing Co. and Precision Castparts make up
more than 22% of the combined share in the basket.
From a sector perspective, 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 $81.5 million.
The fund trades in a small volume of roughly 3,400 shares per
day, suggesting a wide bid/ask spread, increasing total costs
beyond the expense ratio of 0.46% per year.
Power Shares Aerospace & Defense Portfolio
PPA seeks to invest its $45.8 million asset base in 48 stocks,
more than what ITA holds. Although the fund appears to be heavily
invested in the top 10 holdings, the percentage holding in the
top 10 is still less than ITA. The fund invests 51.9% of its
assets in the top 10 holdings.
United Technologies Corp, Honeywell International Inc. and The
Boeing Company occupy the top three positions in the fund (
Try Value Investing with These Large Cap ETFs
The fund charges an expense ratio of 66 basis points and has
returned 7% to investors over a period of one year.
SPDR S&P Aerospace & Defense ETF (
Launched in Sep 2011, the SPDR S&P Aerospace & Defense
ETF is the most recent addition in the aerospace & defense
The fund seeks to invest its total asset base of $13.3 million
in 34 stocks. However, the fund appears to be somewhat
concentrated in the top 10 holdings as it invests 47.2% of its
assets in the top 10 companies.
Among individual holdings, Textron Inc. (5.13%), Triumph Group
Inc New (4.96%) and Transdigm Group Inc (4.85%) occupy the top 3
positions in the fund. Over a period of one year, the fund has
delivered a return of 6% 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.
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ISHARS-DJ AEROS (ITA): ETF Research Reports
LOCKHEED MARTIN (LMT): Free Stock Analysis
PWRSH-AERO&DEF (PPA): ETF Research
SPDR-SP AER&DEF (XAR): ETF Research
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