As the retail sector has rebounded, retail ETFs have become pricey.
With a chill in the air, snow on the ground in some parts of the United States, and holiday music playing at every turn, retailers right now have to be wondering if this holiday season's sales numbers will be music--to their ears.
So far, retail numbers have looked rosy. For the past year, consumers have done a great job of deleveraging their personal balance sheets, which has meant that they have had more money in their wallets, and consumer sentiment has been steadily rising. Recent earnings reports from Wal-Mart
When all the smoke clears, the retail sector as a whole is expected to see growth of 3.5% to 4% for the full-year 2010, with luxury retail expected to be up even more (in the 6% range). Clearly, shoppers are in a buying mood, although thus far, there have been pockets where retail has been a little weaker--furniture, electronics and appliances, and department stores.
Investors looking for an exchange-traded fund to invest in the retail sector have a few options. There are just three retail-only ETFs, one of which is very thinly traded.
Here, we take a closer look at the retail ETFs, along with our take for investors about the attractiveness of each one.
SPDR S&P Retail
This is the 800-pound gorilla of retail ETFs. As one of the 25 most-liquid ETFs of any kind, XRT is a true bellwether for retail investors, with exposure to more than 60 diverse bricks-and-mortar retailers, the overwhelming majority of which are discretionary in nature. In addition, because the index that it tracks is equally weighted, even really large, big-box retailers like Wal-Mart and Target are precluded from making up a large amount of the ETF. In addition, with an annual fee of 0.35%, XRT is a relatively inexpensive way to play the space.
The SPDR has its drawbacks. Its equal-weighted nature means that it holds mostly smaller-cap companies (81% of the fund's assets are invested in small- and mid-cap firms) and, as such, is far more volatile. It does not own home-improvement retailers like Home Depot and Lowe's
One final note: XRT has the most shares sold short of any ETF, with its percentage recently climbing during the month of November to some shockingly high levels (more than 300% short). Clearly, heavy market sentiment believes that XRT and other retail ETFs are poised for a stumble, making a new investment at XRT at this time a clear contrarian play. Similarly, XRT (or any other overvalued retail ETF) clearly is an option for investors interested in shorting the retail sector as a whole.
A more defensive retail ETF is Retail HOLDRS, a concentrated product from Merrill Lynch that consists of just 18 retailers. RTH is suitable for investors who are skittish about the consumer but still interested in some retail exposure. In particular, discount retailers, led by a nearly 19% investment in Wal-Mart, comprise more than 27% of the fund, while home-improvement retailers make up almost 20% and drugstores account for another 11%. As a result, RTH would make a fine choice for investors looking for significant ETF exposure to Wal-Mart or to the home-improvement retailers. In addition, RTH offers investors exposure to the online retailing titan Amazon.com
Some concerns about RTH include the fact that because less of its portfolio is cyclical, there is less potential for a massive rebound. Plus, the home-improvement retail exposure effectively gives RTH some exposure to the ups and downs of the housing sector. Also, although RTH has some exposure to online shopping (chiefly through Amazon, but also through small positions in Best Buy
PowerShares Dynamic Retail
This tiny and thinly traded ETF is a 30-stock portfolio with equal allocations to large-cap, mid-cap, and small-cap names. The fund uses quantitative analysis in an effort to outperform traditional market-cap-weighted ETFs like XRT. The fund charges the highest fee of any retail ETF (0.60% expense ratio), but it has earned that fee for long-term investors, significantly outperforming the S&P 500 since its inception. It also has returned more than 23% for the year to date, or almost double the S&P 500's return in 2010.
An equally-weighted fund that rebalances quarterly, PMR tracks an unorthodox benchmark that selects and ranks stocks using a 25-factor proprietary model that ranks retail stocks by size and by scores based on fundamental growth, valuation, risk, and investment timeliness.
Some of PMR's holdings seem like they are not truly retail names (such as Amerco
PMR clearly has generated some impressive results since it began trading in 2005 and normally would be an appropriate way to play the retail space. However, PMR currently trades above Morningstar's fair value, suggesting that any upside is limited unless consumer spending this holiday season substantially exceeds expectations. Also, because PMR is so thinly traded, investors are advised to keep a close eye on bid-ask spreads and to always use limit orders.
Other Retail ETF Options
Beyond the three pure-play retail ETFs, investors can consider two other ETFs with substantial retail weightings. One, iShares Dow Jones U.S. Consumer Services
Also, Internet HOLDRS, as mentioned above, could be a way for investors to play online retail in the form of Amazon.com and eBay
Robert Goldsborough is an ETF analyst with Morningstar.
Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), Claymore Securities, First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.