by Mike McDermott
ETFs can be excellent trading vehicles, giving broad industry or
asset class exposure in a single trade. Essentially, an ETF is a
basket of stocks or other securities that can be bought in a single
transaction. There are two primary advantages when trading ETFs
most of the time
Lower transaction costs
compared to buying the basket of securities
But not all ETFs are created equal. Some ETFs have liquidity
issues making it difficult to move even modest amounts of capital
on a short-term basis. Others may be comprised of securities that
are not directly tied to the expected focus of the fund. And at
times, the holdings can be so concentrated that the ETF offers
little in the way of practical diversification.
So when trading ETFs, it pays to know the details.
Understanding how a particular ETF will react to different market
scenarios puts a trader in a better position to succeed. A deeper
understanding of the inner workings of individual ETFs allows not
only for proper selection when setting up an individual trade, but
also better conviction (positive or negative) when holding a
Understanding how an ETF is put together helps me to know how a
trade will react in a particular situation. If a retail ETF is
comprised of stocks selling to higher-income customers, I may be
less likely to short this vehicle in an environment where the
has squeezed the lower-income consumer, while more affluent
consumers remain healthy.
Today, we're going to look at two popular homebuilder ETFs. The
SPDR S&P Homebuilders (
iShares DJ US Home Construction (
securities sound like similar vehicles, but behind the scenes they
operate from a very different perspective.
When I look at the US housing market, I'm typically focusing on
the "shadow inventory" of homes likely to hit the market, the
falling prices for both new and existing homes, and the lethargic
level of activity on a nationwide basis.
We have looked at several
vulnerable homebuilders as short candidates
, and another option for taking advantage of the perennially weak
sector may be to pick inflection points using popular homebuilder
When it comes to the actual holdings within the SPDR S&P
) and iShares DJ US Home Construction (
the differences are significant
Starting with XHB, the good news is that there is plenty of
diversification. The ETF is made up of 35 different stock
positions, and the top 10 positions represent only 38% of the
But looking a bit more closely at the individual positions,
XHB looks much more like aretail ETF
than a home building security. The top four positions in the fund
), Pier 1 Imports (
), Tempur-Pedic Intl (
Mohawk Industries (MHK)
Only ONE of these names is even related to
Of course new homes are usually furnished so the positions
arerelated , but this is hardly a "homebuilder" ETF. Rounding out
the top 10 positions, are Best Buy (BBY), Pulte Homes (PHM), Owens
Corning (OC), Leggett & Platt (LEG), Whirlpool (WHR) and Smith
A O Corp. (AOS). Of these positions, only PHM is atrue
So if you're looking for accurate exposure to the homebuilding
industry, XHB is probably not the right vehicle. The positions are
to homebuilding, but there are issues that affect retailers that
may not be the same issues affecting the actual homebuilding
Less Diversification, Better Construction
The iShares DJ US Home Construction (
) fund has a bit more focus when it comes to actual homebuilding
companies. Looking at the top four positions, we have
NVR Inc. (NVR), D.R. Horton (DHI), Lennar Corp.
Toll Brothers (TOL)
All four of these positions are legitimate homebuilders. While
the companies operate in different geographic regions, and are
differentiated by quality and types of homes sold,
they all actuallybuild homes -
a novel concept…
Notice the difference in the chart patterns (
click on each to enlarge
). Instead of the strong upward trend that we see in the XHB retail
names, the actual homebuilders look much more vulnerable.
There are certainly reasons why home-related retailers are
performing better than the actual homebuilders. Logically, it makes
sense for homeowners to spend money improving their existing home.
After all, if you're stuck with a home that you can't sell on the
market, it makes sense to buy some nice flooring, a few curtains
and a new mattress.
As a trader, if I want to make a bet (for
against) the homebuilding industry, I want to make sure that the
vehicle that I choose actually tracks the industry that I am
ITB offers a bit less in terms of diversification…
The top four positions account for roughly 29% of the fund's
assets, and the top 10 positions make up more than half of the
portfolio composition. Low diversification means that if something
out of the ordinary happens to any ONE company, it could have a
larger effect on the ETF.
But even NVR (the largest ITB position) only represents 8.33% of
assets - not enough to cause a major problem.
Liquidity Favors XHB
In terms of liquidity, XHB is by far the more favorable choice.
Trading roughly 4.9 million shares a day, with a security price
near $18.30, the average daily dollar volume is $90.3 million.
That's plenty of liquidity - even for large traders with hundreds
of millions under management (
assuming a manager isn't going to bet the entire farm on this
ITB only trades about 690,000 shares a day, and with a price
near $13.30, that equates to a daily dollar volume of about $9.2
million. If you manage a shop with AUM of $100 million and want to
take a 5% position in the ETF, you're going to have difficulty
putting your position on without significant slippage. But
for most individual and niche prop traders, ITB has plenty
of liquidity for active trading
So while there are a few reasons XHB has developed a reputation
for being the "go-to" ETF for homebuilders (
primarily liquidity and diversification
), ITB is likely the better choice for most traders looking for
exposure to the US homebuilding market.
There's a lot of action in this group right now, with
significant opportunities for nimble traders. Hopefully this ETF
scorecard information gives you some good ammunition for picking
the right vehicle for capturing your profits.
Disclosure: As active traders, authors may have positions long
or short in any securities mentioned. Full disclaimer can be found
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