The Smart Phone ETF

February 18, 2011

I have to admit: I never thought the smart phone ETF would actually make it to market.

When First Trust filed for the product last summer, I thought it would collapse under the weight of its own silliness.

A smart phone ETF? Didn’t we learn anything from the XShares debacle?

I have two major issues with the smart phone ETF. The first, which I’ve expressed before, is simple: There aren’t enough pure-play smart phone companies to make a good smart phone ETF. Most companies in the smart phone space do other things.

Just start from the top of the alphabetical list of FONE’s holdings: Agilent.

Agilent is a fine company. It focuses on broad-based technical measurements, serving a critical role in the life sciences, chemical and electronic industry. The company doesn’t break out revenues exactly, but almost no one considers it a “smart phone” company. It would be generous to suggest that 20 percent of its revenues are linked to the smart phone business.

The problem gets worse as we move through the alphabet. Take Google: The most optimistic pie-in-the-sky mobile analysts say that Google could generate $5 billion in mobile search revenue in 2012. That sounds like a lot, until you consider that the company as a whole will generate $29 billion in revenue that year. A 17 percent exposure to the mobile market warrants inclusion?

How about Samsung? Or Sony? The list goes on.

It’s hard to build good ETFs in niche industries because it’s hard to find pure plays on the industry. Smart phones are as niche as you get. If you really want to invest in smart phones, you’re likely to be better off with a handful of smart phone specific stocks, such as Research in Motion (RIMM).

The bigger issue I have with the smart phone ETF is, however, more general: It strikes me as a triumph of marketing over investor demand.

I’ve read First Trust’s primer on the smart phone market, and agree that the industry is positioned for good revenue growth. But do we know how that will translate into performance for this ETF? Do we know how closely smart phone revenues are correlated with the smart phone index? Do we know where and how a smart phone ETF would fit in an investor’s portfolio?

Maybe I’ll be wrong and investors will rush to this product. Maybe it will deliver returns that are better than and not correlated with the broader technology market.

But color me a skeptic for now.



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