The Best Aerospace & Defense ETF

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About: SPDR S&P Aerospace & Defense ETF (XAR), Includes: AJRD, BA, CW, GD, ITA, LMT, NOC, PPA, SPR, UTX
by: Joseph L. Shaefer
Summary

The plethora of ETFs sometimes makes it seem they all simply copy each other's portfolios.

But some ETFs stand out by using a different approach.

This can make all the difference in the world when it comes to performance.

As a retired military member of many years, I maintain a lifetime subscription to Defense News. Reading specialized publications like this often gives me a little advance warning of trends and players in a particular industry. Returning to roots I know pretty well, and seeing the companies that appear to be best-positioned, I recently advised subscribers I was doing deeper due diligence on the three biggest Aerospace & Defense ETFs. My conclusions follow...

Two of these, the Invesco Aerospace & Defense ETF (PPA) and the iShares US Aerospace & Defense ETF (ITA) are passively-managed capitalization-weighted ETFs. Buying these ETFs gives you the most representation of the biggest companies so Boeing (BA), Lockheed (LMT), United Technologies (UTX), Northrop Grumman (NOC), and General Dynamics (GD) et al dominate. Indeed, here is a showing of the top 10 holdings of PPT…

Source: Fidelity.com

… and here are the top 10 holdings of ITA:

Source: Fidelity.com

They are not identical because each ETF uses a “slightly” different measure for valuation but they are close enough to cause a double-take. I certainly would not buy both of them to get exposure to this key industry.

Then there is XAR, the S&P SPDR Aerospace and Defense ETF. While also passively-managed, XAR is an “equal-weighted” ETF which strives to hold equal percentage amounts of all the aerospace and defense companies listed among the S&P 500. As a result, XAR’s charter provides for the broadest exposure to large-caps, mid-caps and even the occasional mid-small-caps:

Source: Fidelity.com

There is nothing wrong with owning the biggest of the big. They are the ones that make front-page news when they are awarded $5 billion or $10 billion contracts. But you need to know two things about them.

  1. Those contracts are awarded to them as the “prime contractor.” But Boeing or Lockheed or whoever then sub-contract to other firms that occupy (or own) a particular niche that makes them the go-to company to fulfill part of the contract.
  2. The biggest of the big have already been run up in price as a result of being the best-known. But the profit margins of some of the next-tier firms are actually better than the big boys. And I can assure you from personal experience that companies like Aerojet Rocketdyne (AJRD), Spirit Aerosystems (SPR), and Curtiss-Wright (CW), all held by XAR, will get their share of those contracts!

XAR also carries the lowest expense ratio – although we are talking a range of only 0.35% for XAR and 0.60% for PPA. As I regularly advise clients, subscribers, and readers, with apologies to The Eagles, “Get Over It” with this fixation of going cheap for a few pennies difference while potentially leaving $20 bills on the table!

Finally, XAR is the purest play on the industry. All three ETFs are way up there, but the other two own more shares of the conglomerates that are primarily aerospace and defense firms but also have other divisions that do other things.

In addition to buying XAR for my model portfolio I also bought an Israeli firm that I have followed for years and now looks like it is selling at a good entry point. In addition to its holding by XAR, I also added extra shares of the “big” that I consider the leader in electronic warfare, intelligence, surveillance and reconnaissance systems, and future missile defense systems – among a few score other leading-edge technologies. Since we have a free trial, you are welcome to take a look for yourself and ask any questions about those or other positions on my Live Chat board.

Good investing!

Joe

Disclosure: I am/we are long XAR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.