Defense ETFs Outlook Clouded by Debt Burden

Shift to long-term perspective arises as debt service balloons.

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Reviewed by: Lisa Barr
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Edited by: Ron Day

Exchange-traded funds that invest in stocks tied to military spending are grabbing investor attention, now that the panic over the debt ceiling has subsided.  

While defense spending remains in a bull market, the rest of the budget is creating uncomfortable headlines. According to the Peter G. Petersen Foundation, a Washington-based think tank, the cost of paying interest on the country’s existing debt will exceed the $766 billion spent on defense by 2028. That’s 12% of federal spending, down from 15% last decade.  

So, defense investing might now be seen as good offense for long-term investors. For those considering this market area, here are a few branches of the military-related ETF world that help pursue that mission. 

Using etf.com’s ETF Screener, choosing Equity, then Sector, and clicking on Industrials reveals several industries within that sector, including Aerospace and Defense. That produces a set of seven ETFs, of which four are either under $25 million in assets under management or use leveraged. The three others essentially create the “joint chiefs” of the defense ETF world.  

All currently trade around a steep price-to-book multiple of 4x, which is the neighborhood where that ratio stood around the time of the dot-com bubble in 2000, and in late 2021 before the pandemic-induced market decline the next year.  

As is often the case, while the names are similar, the funds from three of the largest ETF issuers allocate stocks differently. They have all been around for at least 11 years, which aids in conducting a thorough peer-to-peer analysis for research-oriented financial advisors and self-directed investors. 

Here is a brief examination of the three: 

The iShares US Aerospace & Defense ETF (ITA) is easily the largest of the group, at $5.6 billion in assets. The fund is akin to a duopoly, with Raytheon Technologies and Boeing Company making up nearly 40% of its assets. In fact, 70% of the fund is held by eight stocks, with another 31 making up the remainder. 

The Invesco Aerospace & Defense ETF (PPA) is more evenly distributed, though its top eight stocks still make up 45% of AUM. This ETF holds 56 companies, the broadest range of the bunch. 

The SPDR S&P Aerospace & Defense ETF (XAR) is the most diversified of the trio, despite owning the fewest number of stocks—33—and no stock has a weight of more than 5%. It’s 0.36% expense ratio is the lowest in the group.  

With 2023’s first half dominated by a small number of large nonindustrial stocks, it may not be surprising that this group lags the S&P 500’s 13% year-to-date gain through Monday’s close.  

Industrials, which includes aerospace and defense, is up just under 3% so far this year, and the returns of these ETFs are similar: PPA +3%, XAR nearly 6% up and ITA with a 1.5% gain. Keeping a lid on gains is Raytheon’s 4% decline this year, which is a reminder that highly concentrated ETFs can cut both ways. 

Interest on the debt has been a slow-burning issue for the U.S., and the recent debt ceiling debate brought more attention to that predicament. However, it did not resolve it.  

And even though military spending will soon be displaced by interest payment obligations atop the annual budget, for ETF investors, the long-term, essential nature of the aerospace and defense industry demands that it be kept under surveillance.  

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.