Consumer ETFs: Buyer Beware

July 31, 2012

Tuesday’s consumer numbers highlight the challenges in choosing a consumer cyclicals sector ETF.

Looking at the data, U.S. consumer spending was unchanged for July, while consumer confidence rose unexpectedly. To add another layer of complexity, personal income ticked higher in July.

So, Americans didn’t spend the extra money they earned even as they grew more confident about the state of economy.

But whatever consumers say or do, investors are betting on the consumer sector. It has outperformed broad U.S. equities year-to-date, and flows to ETFs canvassing the sector have exceeded $600 million for 2012.

But picking the right ETF is anything but easy, as we’ll see.

Just look at the year-to-date performance spread of the top four funds by assets.

The top-performing fund shown in dark blue, the iShares Dow Jones U.S. Consumer Services Index Fund (NYSEArca: IYC) has outpaced the laggard shown in light blue, the First Trust Consumer Discretionary AlphaDex Fund (NYSEArca: FXD) by more than 10 percentage points in just seven months.

Consumer Cyclical YTD SPY


Also note the performance of these four funds relative to the S&P 500, shown in red, as represented by the SPDR S&P 500 (NYSEArca: SPY). Three of the four have beaten SPY so far this year quite handily, while FXD lagged.

This means that choosing among the top ETFs in the space is just as critical as the decision to overweight or underweight the sector in the first place.

Performance Drivers

What sets these funds apart? Le­­­­­t’s start with the outlier, First Trust’s FXD.

Unlike the other three funds that use a plain-vanilla, capitalization-weighted approach to sector coverage, FXD aims to pick outperforming­­­­ stocks in the sector.

While the fund is not actively managed, its rules-based index clearly makes some big bets relative to the plain-vanilla funds—bets that haven’t worked out well so far in 2012.­­­

Even among the three vanilla funds, we can see a 2.5 percentage point difference in year-to-date returns, with iShares’ IYC 14.8 percent beating the 12.3 percent posted by the Vanguard Consumer Discretionary ETF ­(NYSEArca: VCR).

These funds track broad, market-cap-selected and -weighted indexes—plain-vanilla coverage, in other words. The performance differences between the indexes are driven by how they classify consumer stocks.

The top holdings of the funds highlight the differences well: IYC holds retailers like Walmart, while VCR holds auto stocks like Ford Motor. Performance differs greatly between these two names: Walmart is up about 25 percent year-to-date, while Ford has fallen about 14 percent in 2012.

Note that the funds’ treatment of these two stocks isn’t a question of overweighting or underweighting; instead, it’s all or nothing. Walmart is IYC’s top holding, at 7 percent, while the giant retailer is entirely absent from VCR.

These differences in the early months of the year hurt IYC relative to VCR and SSgA’s XLY through May, when Walmart’s stock price surge turned the tide for IYC.

The key takeaway here is that choosing the right sector ETF matters greatly in the consumer space—more so than any other sector, in my view.


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