This report analyzes ETFs that hold stocks of companies involved in the materials sector. The materials sector is a broad category that includes companies involved in industries such as chemicals, construction materials, containers and packaging, metals and mining, and paper and forest products. The bulk of the companies in the sector, however, are in the chemicals and metals/mining industries. In a separate report we will discuss ETFs that cover just metals/mining companies. Companies involved in the materials sector can be loosely defined as commodity producers, along with the three main commodity producer sub-sectors of energy, metals/mining, and agriculture.
Materials Select Sector SPDR Fund (NYSEARCA:XLB) – This fund, launched in December 1998, is the largest ETF in the sector with $2.6 billion in assets under management. The fund tracks all the companies in the S&P 500 index that are classified in the materials sector. The fund holds 31 U.S.-listed stocks with the five largest holdings being Du Pont (NYSE:DD) (11.07%), Freeport-McMoRan Copper & Gold (NYSE:FCX) (10.99%), Dow Chemical (NYSE:DOW) (8.71%), Newmont Mining (NYSE:NEM) (8.46%), and Praxair (NYSE:PX) (7.56%). The sub-sector breakdowns are: chemicals (53.27%), metals & mining (33.07%), paper and forest products (5.29%), containers & packaging (5.02%), specialty retail (1.96%), and construction materials (1.39%). The fund has an expense fee of 0.21%.
iShares Dow Jones U.S. Basic Materials Sector Index Fund (NYSEARCA:IYM) – This fund, launched in June 2000, currently has $1.1 billion in assets under management. The fund tracks the Dow Jones U.S. Basic Materials Index. This fund holds 68 U.S.-listed stocks with the five largest being Freeport-McMoRan Copper (10.73%), Du Pont (8.63%) Dow Chemical 7.60%, Praxair (5.69%), and Newmont Mining (5.61%). The sub-sector breakdowns are: chemicals (52.10%), industrial metals & mining (26.67%), mining (18.34%), forestry & paper (2.73%), and short-term securities and other (0.16%). The fund has an expense fee of 0.47%.
Vanguard Materials ETF (NYSEARCA:VAW) – This fund, launched in January 2004, has $600 million in assets under management. This fund holds 135 U.S.-listed stocks. The fund is benchmarked to the MSCI U.S. Investable Market Materials Index. The fund has similar top 10 holdings as XLB and IYM. This fund has an expense fee of 0.25%. Vanguard does not charge brokerage commissions to Vanguard customers when buying or selling this ETF.
Figure 1: Monthly Overlay Chart of XLB, IYM and VAW
Quantitative U.S. Materials ETFs
There are two ETFs that use rule-based quantitative systems in order to select stocks in the materials sector to try to beat a passive index.
First Trust Materials AlphaDEX Fund (NYSEARCA:FXZ) – This fund, launched in May 2007, has $412 million in assets under management. This fund is based on the StrataQuant Materials Index, which employs the AlphaDEX stock selection methodology and uses fundamental growth and value factors to objectively select materials stocks from the Russell 1000 index that will outperform a passive index. This fund currently shows a 3-year annual return of 0.80%, which is substantially better than the 3-year return of -6.04% for the S&P 500 Materials Index. The fund has a net expense fee of 0.70%.
PowerShares Dynamic Basic Materials Sector Portfolio (NYSEARCA:PYZ) – This fund, launched in October 2006, has only $74 million, which means that it has not gained much traction. The fund is based on the Dynamic Basic Materials Sector Intellidex Index, which is a rule-based system that seeks to outperform a passive index. The fund currently has an expense fee of 0.60%.
Equal Weight and Small-Cap U.S. Materials ETFs
Rydex S&P Equal Weight Materials ETF (NYSEARCA:RTM) – This fund, launched in January 2006, has only $40 million in assets under management. This fund tracks the S&P 500 Equal Weight Index Materials, which weights the materials stocks in the S&P 500 index on an equal-dollar weighted basis rather than on the usual market cap weighted basis. The S&P Equal Weight Index Materials has outperformed the S&P 500 Materials Index over all of the recent time frames. This fund has an expense fee of 0.50%.
PowerShares S&P SmallCap Materials Portfolio (XLBS) – This fund, launched in April 2010, has only $5 million in assets under management. This fund is based on the S&P SmallCap 600 Capped Materials Index. This fund has a low expense fee of 0.29%.
U.S. Leveraged & Short Materials ETFs
ProShares offers a family of materials ETFs that provides a double long (2X) ETF and a short (-1X) and double-short (-2X) ETF. These funds track the Dow Jones U.S. Basic Materials Index, which means that these funds are simply leveraged and short versions of the basic 1X fund offered by the IYM-iShares Dow Jones U.S. Basic Materials Sector Index Fund. Investors should note that one can alternatively obtain double-long (2X) leverage by simply buying IYM on 50% margin, or a short (-1X) materials position by simply shorting IYM in a brokerage account. These ProShares ETFs have a high expense fee of 0.95%. In this family, only the double-long UYM product has a large amount of assets under management at $360 million.
- ProShares Ultra Basic Materials (NYSEARCA:UYM) - $360 million in assets under management (AUM).
- ProShares UltraShort Basic Materials (NYSEARCA:SMN) - $75 million AUM.
- ProShares Short Basic Materials (NYSEARCA:SBM) - $4 million AUM.
iShares S&P Global Materials Index Fund (NYSEARCA:MXI) – This fund, launched in December 2006, has $750 million in assets under management. The fund is based on the S&P Global Materials Index and holds 119 stocks listed around the world. The fund’s top 5 holdings are: BHP Billiton LTD 7.86%, Rio Tinto 5.31%, BHP Billiton PLC 4.43% (NYSE:BHP), BASF (OTCQX:BASFY) 3.75%, Anglo American (OTCPK:AAUKY) 3.36%. The fund has the following sector breakdowns: metals/mining 58.45%, chemicals 33.49%, construction materials 3.58%, paper & forest products 2.63%, containers and packaging 1.70%, short-term securities 1.02%. The fund has an expense fee of 0.48%.
There are three other ETF products in the global materials sector, but none has more than $50 million in assets under management and therefore we would recommend staying away from these products unless they can build more traction:
- WisdomTree International Basic Materials Sector Fund (DBN) - $46 million in assets under management (AUM).
- SPDR S&P International Materials Sector ETF (NYSEARCA:IRV) - $35 million AUM.
- iShares MSCI ACWI ex US Materials Sector Index Fund (NYSEARCA:AXMT) - $7 million AUM.
Emerging Markets Materials ETFs
There are two ETFs currently available in the materials sector that specifically focus on emerging market stocks. EMMT (see below) has only $8 million under management so we recommend staying away from this product unless the fund has build its asset level. We like the CHIM-Global X China Materials ETF based on its theme of getting exposure to the materials sector in China, although the fund currently only has $35 million in assets under management. This fund should therefore be approached cautiously until it builds assets under management and provides a stronger track record.
- Global X China Materials ETF (NYSEARCA:CHIM) – This fund, launched in January 2010, currently has $35 million in assets under management. The fund is based on the Solactive China Materials Index. This fund holds 28 stocks with 62.84% in the metals and mining sector and 37.27% in the Chemicals sector. This fund has a fee of 0.65%.
- iShares MSCI Emerging Markets Materials Sector Index Fund (NASDAQ:EMMT) – This fund has only $8 million in assets under management.
“ETF - Best in Class” Investment Conclusions
Our “Best in Class” choice for the materials sector is the iShares S&P Global Materials Index Fund (MXI), which has $750 million in assets under management. This is the only real choice in the global materials group (as opposed to the U.S.-listed materials group) since the other funds all have very low assets under management. Our general recommendation is for investors to seriously consider choosing the global materials ETF, rather than a U.S.-listed materials ETF, because the mining and chemicals industries are truly global industries and there are many quality companies that are listed outside the U.S. The performance between MXI and the U.S.-listed materials ETFs has not been much different in recent years (see Figure 3), but we would still expect the global MXI to outperform the U.S.-listed stocks over the next 5-10 years as the global development theme plays out.
For investors that are nevertheless looking for a U.S.-listed materials ETF our choice is the iShares Dow Jones U.S. Basic Materials Sector Fund (IYM). We chose IYM mainly because of its recent outperformance compared with its two main competitors (see Figure 1) and because we like the diversification effect of holding 68 stocks versus only the 31 stocks held by XLB. IYM has an expense fee of 0.47% that is higher than XLB (0.21%) or VAW (0.25%), but the fund’s recent outperformance more than makes up for the higher expense fee. Vanguard customers who are fee-sensitive may want to choose the Vanguard Materials ETF because of its low expense fee of 0.25% and because Vanguard does not charge its customers brokerage fees for trading VAW.
For investors who are looking for a U.S.-listed fund that tries to beat the passive indexes, the First Trust Materials AlphaDEX Fund (FXZ) has provided attractive returns relative to the passive indexes. There is no guarantee that this outperformance will continue, but the fund has a very good track record, as seen in Figure 2.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.