Equity: U.S. Aerospace & Defense
There are three ETFs that attempt to provide exposure to the US Aerospace and Defense industry: ITA, XAR and PPA. All three use different strategies to tackle the industry's high
“None capture the market perfectly” concentration problem (the industry is dominated by two firms, United Technologies and Boeing). As a result, none capture the market perfectly.
ITA is the most plain-vanilla of the three; it merely caps the weights of the biggest securities to meet diversification requirements. XAR is also relatively vanilla—it holds most of the same securities as our benchmark—but it weights its holdings equally, tilting it even smaller than ITA. The last fund, PPA, uses a different industry classification system to pick stocks, and thus includes a few companies outside our benchmark's scope.
Traders of all sizes will see the best execution with ITA or PPA. XAR is far from untradeable, but is not as liquid as its peers.
XAR offers its exposure at the lowest expense ratio—just 35 bps. In comparison, ITA charges 44 bps and PPA charges 66. Despite not having the lowest expense ratio in the segment, ITA earns our Analyst Pick for its solid tracking performance (after factoring in expense ratio), great retail liquidity and having the most market-like exposure. (Insight updated 08/17/17)
ETF.com Efficiency Insight
The three aerospace & defense funds are all reasonably efficient. The top-scorer, XAR, is also the cheapest at 35 bps, but loose tracking means it only barely edges out second-cheapest
“The three aerospace & defense funds are all reasonably efficient.” fund ITA, which charges 11 bps more.
In comparison, PPA's 66 bp expense ratio seems excessive. Its high fee is accompanied by poor tracking. Note that PPA's apparent outperformance is an artifact of its tracking a price-return index. While we've accounted for this in calculating its Efficiency score, the fund's true holding cost is difficult to measure.
All three funds in the segment should be stable for the foreseeable future. ITA and PPA both have solid asset bases and, while XAR has only about $80M, it is unlikely to get shut down by State Street.
XAR paid out capital gains in 2013, a taxable event for investors and a common problem for equal-weighted funds, though the distribution was tiny. The other two funds have been tax efficient. (Insight updated 08/17/17)
ETF.com Tradability Insight
ITA and PPA trade well at the retail level. ITA in particular trades over $3M on a typical day, at tight 6 bp spreads. PPA sees relatively smaller volume and looser spreads, but is still
“ITA and PPA trade well.” very accessible to retail investors and has stellar block liquidity. XAR may be expensive to access due to low volume and spreads in excess of 15 bps, but that shouldn't be a deal-breaker by itself.
Institutional traders should have no problem executing trades for any of the funds, as all three have perfect block liquidity score. (Insight updated 08/17/17)
ETF.com Fit Insight
The aerospace & defense industry’s high concentration limits the degree to which ITA, PPA and XAR can capture the market. ITA and PPA both aim to deliver broad market-like
“All 3 funds underweight the largest companies in the industry” exposure by tracking market-cap-weighted indexes focused on the industry. Both funds cap individual security concentration to comply with diversification rules, but despite this handicap, ITA and PPA do a decent job of fitting our segment benchmark. XAR doesn’t aspire to be representative; instead, the fund equally weights its holdings to provide diversified exposure.
Different methods of defining the companies in the industry result in substantially different holdings. Of the 3 funds, PPA provides the least pure exposure. ITA and XAR invest the majority (about 90%) of their portfolios in pure-play aerospace & defense companies, while PPA only invests 70%. PPA’s broader scope leads to inclusion of IT services & consulting companies and communications equipment industries.
All 3 funds underweight the largest companies in the industry and overweight the small ones, resulting in a small-cap tilt for each fund. This diversification reduces each fund’s single-stock risk. Of the 3 funds, ITA has the most concentrated portfolio, with about 9% positions in both United Technologies and Boeing. XAR tilts the smallest of the three, with a market cap of just $21B, but even ITA and PPA don't come close to our benchmark's $58B.
Overall, each fund does the best it can to address the industry’s highly concentrated nature. ITA captures the theme the most closely, while PPA uses a different classification system that results in a different picture of the industry and XAR offers equally weighted pure-play exposure. (Insight updated 08/17/17)