M&A activity in the food industry puts a pair of similar but quite different related ETFs in focus.
The food industry is currently buzzing with merger news surrounding Tyson Foods’ $8.5 billion bid for Hillshire Brands Co., driving Hillshire’s stock up 5 percent in the past week, while Tyson securities have tumbled more than 11 percent.
Investors in the $155 million Guggenheim S&P Equal Weight Consumer Staples ETF (RHS | B-80) and the $5.5 billion Consumer Staples Select Sector SPDR Fund (XLP | A-91), which both hold Tyson, have seen the value of their ETF shares drop 1 percent in the same period.
Year-to-date, RHS has gained 7.5 percent, while XLP is up 4.6 percent. Last year, RHS was up 32.5 percent, while XLP trailed with a 26.3 gain.
The difference in returns is entirely attributable to the weighting difference, according to Spencer Bogart, an ETF specialist at ETF.com: “They both hold the exact same 40 securities—just in different weights.”
Chart courtesy of StockCharts.com
Looking At P/E Ratios
Both ETFs have exposure to household names such as Procter & Gamble Company, Coca-Cola and Philip Morris International. But while XLP currently makes these stocks its top three holdings, RHS’ equal-weighted portfolio is tilted toward smaller-cap stocks.
So, lesser-known stocks such as Lorillard Inc., a tobacco company; Molson Coors Brewing Company; and Altria Group, another tobacco concern; are the top three securities in RHS’ portfolio.
“I would also expect RHS’ equal-weighting to boost its P/E ratio,” Bogart said. He notes that equal weighting tilts toward smaller companies and smaller companies are usually more growth oriented. Thus, investors pay a higher price for current earnings in expectation that the denominator of the P/E ratio will grow moving forward.
However, he adds that RHS’ P/E ratio is lower than XLP’s, but that anomaly probably doesn’t amount to much because each fund only holds 40 companies, and one very richly valued but larger company could distort XLP's P/E ratio.
Steep Climbs, Sharp Drops
Investors also need to grasp that while smaller-caps rise more rapidly in a bull market, they also tumble much more quickly than larger-cap stocks in a bearish market.
Additionally, sundry costs of fund ownership matter too, and XLP’s 0.16 percent annual expense ratio—amounting to $16 for every $10,000 invested—is less than half that of RHS, which has an annual expense ratio of 0.40 percent.
Among other costs that can rear their head is tracking error, or the difference between the return an investor receives and the return of the index. XLP comes in with tracking error of -0.26 percent versus -0.71 percent for RHS, resulting in higher transaction costs for RHS.
Getting further under the hood, XLP’s huge liquidity advantage over RHS results in an average bid/ask spread of 0.02 percent versus 0.07 percent, meaning investors in XLP will keep more of their returns in their pockets.
That means the price of RHS may move higher relative to XLP at any given point in a volatile market, taking away a slice of the ETF’s returns.