Evaluating Counter-Trend Opportunities In Retail ETFs

Retail stocks have become a highly-publicized area of the market in recent years as the continued struggle for brick and mortar relevance battle the efficiency of online sales. The trend has been exacerbated with the steady expansion of retail juggernaut Amazon Inc (AMZN) into more and more households. The strength of Amazon has unavoidably weighed on the share prices of more traditional retailers that find themselves strung with slowing sales and inescapable costs.

There is no doubt that consumerism is alive and well in the heart of the American economy. Which is why it’s worth considering if the pendulum of momentum will eventually swing back in the direction of numerous stalwart retail competitors.

One way to gauge and potentially invest in this trend is through diversified exchange-traded funds (ETFs) that track a basket of retail stocks. The SPDR S&P Retail ETF (XRT) is by far the largest and most widely followed ETF in this space. XRT owns approximately 100 shares of publicly-traded retail companies that are primarily domiciled in the United States. This includes industry sub-sectors such as apparel, automotive, food, department stores, drug stores, specialty retail, and electronics. The fund currently has $850 million in total assets and charges a net expense ratio of 0.35%.

The most interesting feature of XRT may be its equal-weighted composition. Each stock within the index is given an equally proportionate share of the asset allocation to provide smaller companies the opportunity of making a meaningful impact on performance. Companies like AMZN are given the same weighting as Costco Wholesale Corp (COST), Ulta Beauty Inc (ULTA) and Walgreens Boots Alliance Inc (WBA) at each rebalancing period.

It’s worth noting that the price trend of XRT has been quite volatile over the last several years with little net gain overall. This tug-of-war among the underlying holdings demonstrates a lack of definable trend for the group amid a roller coaster of peaks and valleys.

Perhaps the more important issue with the performance of retail stocks is how strong the rest of the market has been in their absence. The ratio of momentum between XRT and the SPDR S&P 500 ETF (SPY) just recently hit a new three year low to start off 2017.

Investors who are seeking contrarian or deep value plays may be intrigued by the potential for a turnaround in the retail sector. However, the greatest challenges will be in timing this momentum swing and selecting an appropriate way to play it.

XRT is the obvious investor favorite based on its size and longevity. Nevertheless, there remain alternative options in the ETF category that make compelling cases as well.

The next largest competitor is the VanEck Vectors Retail ETF (RTH), which has $72 million in assets and charges a similar 0.35% expense ratio. RTH varies its approach by honing in on just the 25 largest retail names in a more traditional market-cap weighted structure. Because of its index construction criteria, AMZN accounts for 17% of the underlying exposure, with Home Depot Inc (HD) and Wal-Mart Stores Inc (WMT) rounding out the top holdings.

The newly launched Amplify Online Retail ETF (IBUY) is another intriguing option as well. This fund focuses on 40 publicly traded stocks that derive more than 70% of their revenue from online sales. IBUY follows a modified equal weight index methodology to create a level playing field across all its underlying holdings.

This ETF also captures multiple market cap segments and contains some modest international exposure as well. IBUY is truly designed for those investors who believe in the continued trend of online retail sales growth and profitability. Nevertheless, investors should be aware that the unique strategy charges an expense ratio of 0.65%, which is on the high side for its peer group.

The Bottom Line

Sector investing is often a hit-or-miss endeavor that can be fraught with missteps in timing or execution. ETFs of this nature are generally more appropriate as smaller tactical holdings to supplement core, broad-market exposure. This allows you to participate in the returns of the sector without significantly overweighting your allocation towards a single industry trend.

Furthermore, those who are considering using a retail ETF should carefully evaluate the underlying index construction criteria as there are many varying methods within this group. The allocation of capital to stocks within each unique fund will play a meaningful role in its overall performance.

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

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

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