Consumer Staples ETFs - A Necessary Ingredient For Every Portfolio

Includes: FXG, KXI, RHS, VDC, XLP
by: Aaron Barton

The average beta of these funds is a very low .62.

The top 10 holdings of each ETF are flush with dividend aristocrats and other solid long-term plays.

With an average of 63 holdings and five year annual returns of 16.53%, each of these consumer staples ETFs warrants a close look.

Investopedia defines consumer staples as "essential products such as food, beverages, tobacco and other household items" that consumers are "unable or unwilling to cut out of their budgets regardless of their financial situations."

So there are companies that focus on selling products that people either have to or really want to buy, whether or not they can afford them? Sign me up. I learned about the draw of consumer staples stocks after the birth of my awesome, first, and only daughter. I learned that there really are things that must be purchased regardless of my financial situation. While diapers was chief among that list, I also found that many of the cheap off-brand products I had grown accustomed to ever since getting out on my own and that my patient wife slowly replaced with name brand alternatives were made by many of the companies held by these ETFs. So i figured if you can't beat them, invest in them.

That mindset of investing in what you know or use is exactly why consumer staples ETFs can make sense for the passive investor. You use or see many of their products every day, from the Gillette razors you shave with and Monster (NASDAQ:MNST) Energy drink you chug in the morning, to the Costco (NASDAQ:COST) or Kroger (NYSE:KR) you shop with on the weekends. Whether its Marlboro cigarettes you gave up years ago or the Budweisers you didn't, the companies that make these products and those that sell them can be a boon to your portfolio simply because these companies (and their products) are everywhere.

Profiling the contenders (unless otherwise stated, market prices, NAV and SEC yield as of 1/30/15). See bottom of article for top ten holdings by fund.

Vanguard Consumer Staples ETF (NYSEARCA:VDC)

This ETF seeks to track the performance of a benchmark index that measures the investment return of stocks in the consumer staples sector. It includes stocks of companies that provide direct-to-consumer products that, based on consumer spending habits, are considered non-discretionary.

  • Market price: $123.44
  • 30-day SEC Yield: 2.33%
  • Number of holdings at 12/31/14: 100

iShares Global Consumer Staples ETF (NYSEARCA:KXI)

This ETF seeks to track the investment results of an index composed of global equities in the consumer staples sector. It offers exposure to companies that produce essential products including food, tobacco, and household items.

  • Market price: $90.98
  • 30-day SEC Yield: 2.18%
  • Number of holdings at 01/29/15: 99

Guggenheim S&P 500 Equal Weight Consumer Staples ETF (NYSEARCA:RHS)

Seeks to replicate as closely as possible, before fees and expenses, the performance of the S&P 500 Equal Weight Index Consumer Staples.

  • Market price: $104.01
  • 30-day SEC Yield: 1.70%
  • Number of holdings at 01/30/15: 39

Consumer Staples Select Sector SPDR (NYSEARCA:XLP)

The fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P Consumer Staples Select Sector Index.

  • Market price: $47.88
  • 30-day SEC Yield: 2.35%
  • Number of holdings at 01/30/15: 41

First Trust Consumer Staples AlphaDex (NYSEARCA:FXG)

The fund seeks to provide investment results that correspond generally to the price and yield, before fees and expenses, of an equity index called the StrataQuant Consumer Staples Index.

  • Market price: $42.90
  • 30-day SEC Yield: 2.35%
  • Number of holdings at 01/30/15: 41

1) Diversification

Diversification is the process of reducing non-systematic risk by investing in a variety of assets and companies whose values do not move up or down at the same time. This can be achieved by investing in ETFs that have a number of holdings that operate in a sufficiently broad array of sub-sectors or industries. This list evaluates both the number of ETF holdings and sub-sector representation.

a) Number of holdings

Winner: iShares. The Global Consumer Staples ETF has nearly one hundred holdings at its top 10 holdings make up less than half of the funds total net assets.

b) Sub-sector representation

Vanguard Consumer Staples ETF

Courtesy of Vanguard

iShares Global Consumer Staples ETF

Courtesy of BlackRock

Guggenheim S&P 500 Equal Weight Consumer Staples ETF

Courtesy of Guggenheim

Consumer Staples Select Sector SPDR

Courtesy of State Street Global Advisors

First Trust Consumer Staples AlphaDex

Courtesy of First Trust

Winner: Vanguard. The Vanguard ETF has a solid blend of retailers and producers, tobacco, soft-drinks, household products and alcoholic beverages.

2) Expense ratio

Expense ratio is the total of a funds operating expenses, expressed as percentage of average net assets. These expenses include management fees, Distribution/service or "12b-1" fees, custodial, legal, accounting, etc. Lower expense ratios, either through larger ETF size or smaller nominal expenses means higher investment returns. Lower fees are one of the primary advantages of ETFs relative to actively managed funds or assembling a portfolio of stocks on your own.

Winner: Vanguard. Vanguard's rock bottom fees can result in thousands in savings over an investing lifetime.

3) Total Return

Winner: First Trust. The First Trust ETF has outperformed the S&P 500 (as measured by the performance of the iShares Core S&P 500 ETF (NYSEARCA:SPY)) by the widest margin over 1, 3 and 5-year time frames. Past performance does not guarantee future results, but the "enhanced" indexing methodology employed by the fund, which gives weight to price to cash-flow, sales and book value and return on assets has consistently outperformed the market.

4) Valuation Multiples

Winner: Tie, SPDR and First Trust. While the earnings streams of both of these funds are slightly more expensive than those of the S&P 500 (19.79x earnings as of 1/30/15), these funds beat their competitors by a slight margin.

5) Liquidity

Liquidity refers to how easy it is to buy or sell an asset. Generally speaking, the higher the trading volume of an ETF, the more liquid it is. This is important because higher liquidity means tighter bid-ask spreads. In extreme circumstances, thinly traded ETFs may result in the inability to profitably exit a trade.

Winner: SPDR, by a long shot. While First Trust and Vanguard both offer reasonably active markets, if safety means being able to sell an investment quickly for close to NAV, SPDR is the first and only choice.

6) Yield

Yield is an expression of annual income divided by share price. While total returns are a much better indicator of performance, many investors are concerned with how much current income a stock or ETF pays.

Winner: Tie. Vanguard and SPDR. Both ETFs offer 10% higher yield than their better diversified but less focused S&P 500 brother. Yield is not everything. But when it is, look to Vanguard or SPDR.

7) Volatility

Volatility is a statistical measure of returns for a security against itself or more commonly, a market or index. Lower volatility usually corresponds to lower risk. Beta, a measure of volatility, represents a security's price tendency to change as a result of changes in market prices as a whole. Alpha is a risk-adjusted measure of performance relative to a benchmark index. The excess return of an ETF relative to a benchmark is the ETF's alpha. For an investor (as opposed to a trader) lower beta/volatility and higher alpha are good things.

Winner: Toss-up. All of these funds have relatively low volatility and positive alpha over both three and five-year horizons.

8) Dividend history and growth

Winner: SPDR, while all of these funds paid out less in 2013 than in 2012, the SPDR fund had the lowest drop and continued increasing dividends in 2014.

So, which Consumer Staples ETF should you own?

Vanguard or SPDR! Vanguard and SPDR both have very low absolute fees and relative to their ETF alternatives, have outperformed the S&P 500 over the past five years. While both funds earnings' streams are slightly more expensive than the S&P 500, they compensate investors for this premium with higher yield. All funds profiled have positive alpha and low beta.

A word of caution

As alluded to above and detailed below, over 25% (and in some cases over half) of these ETFs performance is determined by just ten holdings. A significant downturn in just a couple of these stocks can impact ETF pricing as a whole. Review your funds holdings, rebalance as necessary, and don't sweat the whole diaper thing. It only lasts for a couple of years.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.