A Comprehensive Guide to Aerospace & Defense ETFs - ETF News And Commentary

The aerospace and defense sector is getting accustomed to budgets cuts and the easy upward slope of last year is likely to hit a plateau. While the word “sequestration” rang an ominous bell for the defense industry last year, the budget cuts are now likely to be compounded this year and the next. Notably, the major defense contractors are expected to feel the pain all the more severely.
 
Last year, the industry emerged relatively unhurt thanks to fleet renewals at airlines worldwide with more fuel efficient aircraft, a growing international market for the F-35 Joint Strike Fighter and increasing application of unmanned aircraft in contemporary warfare.
 
Growing commercial opportunities on the heels of an improving global economy, a pick-up in defense spending in some countries and technological innovation and acquisitions actually made up for the military budget cuts. Again, mounting tensions in Eastern Europe could act as a catalyst in this muted budget scenario.

The increasing aggressiveness of Russia could compel Western countries in Europe to finally open up their pockets and spend on defense to fight this latest threat (read: Top Ranked Defense Stocks and ETFs Ready to Explode Higher).
 
On the other hand, strong performance in the commercial aerospace sector is being driven by growing demand for passenger air travel worldwide and by accelerated replacement of obsolete aircraft with more fuel-efficient models.
 
ETFs to Tap the Sector
 
Below, we highlight the ETFs in the aerospace and defense sector, which primarily have a U.S. bias. Investing in these funds in basket form greatly reduces the risk of investing in particular stocks.  (See all industrials ETFs here)

Moreover, if one is interested in playing a sector, ETFs have an edge because it comes in a packaged form that gives instant access to a specific sector, the aerospace and defense sector in this particular case. Aerospace and defense stocks have in fact performed well in the first three months of the year and the benefits of the same have trickled down to the defense ETFs.
 
SPDR S&P Aerospace & Defense ETF XAR
 
This fund follows the S&P Aerospace & Defense Select Industry Index, focusing on the aerospace and defense sector of the S&P Total Market Index. The Index is one of 19 S&P Select Industry Indices, each designed to measure the performance of a narrow sub-industry or group of sub-industries as defined by the Global Industry Classification Standards. (Read: Solar ETFs shine on Trina Solar earnings beat)
 
With a Zacks ETF Rank #1 (Strong Buy), this fund charges investors just 35 basis points a year in fees for its exposure. Hence, it is considered the cheapest option in the aerospace and defense ETF market.
 
With holdings of 36 stocks, the top spots are taken up by Alliant Techsystems Inc., Spirit AeroSystems Holdings Inc. Class A. and Curtiss-Wright Corporation, comprising 3.74%, 3.74% and 3.73%, respectively, of total net assets.
 
Launched in September 2011, this index has a 99.48% focus on U.S companies with the balance 0.52% on others.
 
The fund so far has managed assets of $50.8 million and has an annual dividend yield of 1.22%. The top 10 companies hold a 36.92% share of total net assets. The average daily volume is about 5,972 shares.
 
iShares U.S. Aerospace & Defense ETF ITA
 
With a Zacks ETF Rank #1 (Strong Buy), ITA has provided a positive return of 47.54% over the one-year period ended March 31, 2014. This fund tracks the Dow Jones U.S. Aerospace & Defense Index, providing exposure to companies related to the aerospace and defense industry in the U.S. equity market.

This index has a 99.84% focus on U.S companies with the balance 0.16% on others. The fund has an annual dividend yield of 1.07%. (Read: Regulatory Letdown--Not for these insurance ETFs)
 
The ETF, launched in May 2006, presently has nearly $398.3 million in AUM and is heavily weighted toward the Industrials sector (97.3%) with minimum affinity to Consumer Discretionary and Information Technology. This fund holds 38 stocks with about 57.44% invested in the top 10 holdings.
 
Among individual holdings, the top stocks in the ETF include United Technologies Corp., The Boeing Co. and Lockheed Martin Corp. comprising 9.57%, 8.97% and 6.41%, respectively, of total net assets. With a lilt toward large cap companies, this fund charges investors 45 basis points a year.
 
Aerospace & Defense Profile PPA
 
This ETF tracks the SPADE Defense Index, holding 51 securities in its basket and has an expense ratio – an annual fee – of 0.66%. The Index is designed to identify a group of companies involved in the development, manufacturing, operations and support of U.S. defense, homeland security and aerospace operations. The index was launched in October 2005.
 
This fund is highly focused on U.S companies (99.17%) with the balance 0.83% on others. The fund so far has managed assets of $98.8 million. The top 10 companies hold a 53.66% share of total net assets. The average daily volume is about 33,519 shares and the fund has an annual dividend yield of 1.20%.
 
In terms of holdings, The Boeing Company, United Technologies Corp. and Honeywell International Inc. occupy the top three positions in the basket comprising 6.61%, 6.58% and 6.46%, respectively, of total net assets.
 
To Sum Up
 
In spite of the difficult budget scenario, the aerospace and defense sector is holding up well. The defense biggies are proactive in meeting evolving customer needs, particularly for affordable products, besides engaging in corporate restructuring. Moreover, escalating tensions in Eastern Europe and demand for defense products in the Middle East and other Asian nations might drive demand. In this context, the abovementioned ETFs with favorable Ranks might be a good idea to play defense.
 
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