Communicate With The Telecom Sector Via ETFs

by: Ron Rowland

Not so long ago, telephones were connected to wires. What a quaint idea. How would today's teenagers survive? Back then you could only talk on your phone — no text messaging. Even worse, phones didn't even have buttons to push! You dialed by turning a big knob with your finger.

Phone companies were regulated monopolies for decades — mostly the regional "Bell" companies owned by American Telephone & Telegraph. The ticker symbol was a simple "T" just as it is now. When your broker recommended "Telephone," you knew he meant AT&T.

Reliable dividends made T the classic "widows and orphans" stock.
This is not so anymore. Telecom today is a witches' brew of old-guard phone companies and speculative technology names. Yet you can still get involved with just one trade — if you pick the right ETF. Today we'll look at the choices and see which may be right for you.

Telecom: Forgotten Sector?

Sector-oriented investing was still fairly unusual as recently as the mid-1990s. Select Sector SPDRs were the first to let ETF investors Unbundle the Stock Market by industry. Even then, telecom stocks were recognized as a distinct sector. Yet the index methodology of the time forced SPDR to combine Technology and Telecom into one ETF: SPDR S&P Technology (NYSEARCA:XLK).

XLK has done well over the years. Unfortunately, by shoving Telecom to the back of the drawer, the early ETF pioneers also put it "out of mind" for millions of investors. Today you have more choices (including some from SPDR), but many ETF investors still overlook the telecom sector. The combined size of all telecom ETFs is less than $2 billion.

This is regrettable because, depending how they are constructed, Telecom ETFs can help two groups of investors:

  • Income investors who love price stability and high yield and …
  • Growth investors who want fast-growing businesses.

What does this mean? Not every telecom stock is equal. Here in the U.S., the phone market is more or less saturated. Everyone has a mobile phone. The only exceptions are young children and the very elderly. Landline usage is plunging.

The U.S. phone business has come full circle. AT&T and Verizon (NYSE:VZ) don't have a legal monopoly like their predecessors, but they do have a practical monopoly. Their huge infrastructure investments (cell towers, etc) act as a barrier to competition. While new developments like smartphones and tablets have an impact, U.S. telecom is regaining its utility-like characteristics: Slow growth but consistent dividends. Ditto for phone companies throughout the developed world.

Yet some telecom stocks still have huge growth potential. In emerging markets like China and India, hundreds of millions of people still don't have their own communications device. The possibilities are even greater in frontier markets. Plenty of remote regions still lack phone service.

Telecom Income vs Telecom Growth

Where does this lead us? Here is my conclusion:

  • Telecom ETFs covering the U.S. and other developed countries are more income-driven.
  • Telecom ETFs that own companies from emerging and frontier markets are more volatile and have higher growth potential.

Of course, I'm generalizing here. Every rule has exceptions. As a practical matter, many telecom ETFs offer a mixture of growth and income. If you're looking to add some moderate-risk telecom exposure to your ETF portfolio, you can focus on a handful of U.S. domestic sector ETFs such as:

  • iShares Dow Jones U.S. Telecommunications (BATS:IYZ)
  • Vanguard Telecommunications (NYSEARCA:VOX-OLD)
  • Focus Morningstar Communications Services (NYSE:FCQ)

A second ETF group holds both U.S. and international telecom stocks. Your choices include …

  • iShares S&P Global Telecommunications (NYSEARCA:IXP)
  • First Trust NASDAQ CEA Smartphone Index Fund (NASDAQ:FONE) — this ETF has only about a third of its assets in telecom stocks

The third group omits the U.S. and holds only non-U.S. telecom stocks. Some examples from this category are …

  • SPDR S&P International Telecommunications (NYSEARCA:IST)
  • EGShares Telecommunications GEMS (NYSEARCA:TGEM)
  • iShares MSCI ACWI ex US Telecommunications Services (NYSEARCA:AXTE)

TGEM is particularly interesting because it specializes in emerging market telecom stocks. IST and AXTE have some as well, but they also include European and Japanese telecom stocks. Another caution: Some of these ETFs are small and potentially illiquid. Always use a limit order when buying or selling ETFs.

Is Telecom for you? Maybe so. Do your research and find out if any of these ETFs fit your goals.

Disclosure: Long VOX. No positions in any of the companies or ETF sponsors mentioned.