Time to Hang Up on Global Telecom ETFs?
In a market environment that has put a premium on playing defense, it is not surprising that telecommunications has been one of the top-performing sectors. Within the S&P 500, telecommunications is the smallest sector weight at just under 3.3 percent, but that diminutive status belies the stellar returns offered by the likes of AT&T (NYSE: T) and Verizon (NYSE: VZ).
Year-to-date, the two Dow components have jumped 23.1 percent and 10.5 percent, respectively. Given the commanding weights AT&T and Verizon have in domestically-focused telecom ETFs, it is no surprise those funds have been stalwarts as well.
Telecom ETFs with a global bias have been a different story and following a recent rally for global telecom issues, iShares Global Chief Investment Strategist Russ Koesterich said it might be time to lighten the load. In a recent blog post, Koesterich said his neutral stance on international telecoms is based on valuation.
"As discussed in previous posts, while I believe that investors should emphasize dividends in their portfolios, this does not mean paying any price for income," wrote Koesterich. "Telecom still provides a rich yield, but the cost of generating that income stream has risen. The sector as represented by the S&P Global Telecommunications Sector Index now trades at approximately 1.8x price-to-book (P/B), a premium to its average valuation over the past five years. The stocks also appear increasingly expensive based on price-to-earnings (P/E), with the sector trading at 15.4x earnings, a hefty premium to its history."
The The iShares S&P Global Telecommunications Sector Index Fund (NYSE: IXP) features a 30-day SEC yield of almost five percent and the $576.4 million fund allocates 29 percent of its weight to AT&T and Verizon.
IXP is up almost eight percent year-to-date. However, the iShares Dow Jones U.S. Telecommunications Sector Index Fund (NYSE: IYZ), which also devotes about 29 percent of its weight to AT&T and Verizon, has surged 14.5 percent this year. IYZ has a 30-day SEC yield of 3.14 percent.
The dominance of domestic telecom ETFs does not end with the rivalry between IXP and IYZ. The Vanguard Telecom Services ETF (NYSE: VOX), which features an expense ratio of just 0.19 percent, is up 14.3 percent this year. VOX allocates almost 45 percent of its weight to Verizon and AT&T.
Despite a robust dividend yield of 6.2 percent, the SPDR S&P International Telecommunications Sector ETF (NYSE: IST) is the laggard of the group with a year-to-date gain of just 0.13 percent.
Compounding the woes for global telecoms is mediocrity profitability as Koesterich points out.
"Based on return on assets (ROA), telecom companies are also less profitable relative to their history than other sectors," the iShares strategist wrote. "In other words, while most segments of the market are experiencing above-average profitability, this is no longer true for global telecom companies in aggregate. Mediocre profitability is also evident on a relative basis; comparing the return-on-equity (ROE) of the sector at 11.2% to the global sector average of 21.2% also suggests that telecom stocks now look less compelling as compared to other sector plays."
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