Two homebuilder ETFs with similar labels but very different subindustry exposures.
Over the years, exchange-traded funds have been lauded for their transparency and simplicity. For the most part, that's still true. Of course, as more and more ''exotic" products are introduced, the "know what you own" mantra rings even truer. But no matter the ETF, it always pays to look beyond the label.
Even some older, traditional index-based equity ETFs have undergone changes in their index composition over time that have altered the subindustry exposures they offer. Take, for instance, a couple of the homebuilder ETFs. Some may be surprised at how the allocations to actual homebuilders can vary so widely by similarly named funds.
So, You Want to Add Some Exposure to Homebuilders ...
Investors seeking exposure to the homebuilding industry could consider SPDR S&P Homebuilders
What's under the Hood?
ITB aims to replicate the Dow Jones U.S. Select Home Construction Index, a float-adjusted, market-capitalization-weighted index of 26 companies. Only half of the fund's constituents are actual homebuilders, but these companies account for about 70% of the portfolio. The top three holdings include NVR
XHB aims to replicate the S&P Homebuilders Select Industry Index, an equal-weighted market-cap index. Here, only about 35% of the fund's assets (or eight out of the 26 holdings) is invested in homebuilders. The fund also invests in other subindustries such as building products, home furnishings, home-improvement retail, and home-furnishing retail. As a result, investors in this ETF will hold companies like Home Depot, floor-covering company Mohawk Industries
A quick note on fees and liquidity is also in order here. XHB, which charges a 0.35% expense ratio, is very liquid and trades about 6 millions shares a day, as compared with ITB, which charges 0.48% and trades about half a million shares a day. While most retail investors shouldn't encounter any liquidity issues, those considering very large trades may side with XHB.
Economic Drivers and Fundamentals to Consider
The bursting of the housing bubble, accompanying credit crisis, and economic downturn have devastated homebuilders and the broader housing industry. According to the S&P/Case-Shiller Indexes, housing prices in major markets are off more than 30% from peak levels and are trending near 2004 levels. The National Association of Retailers estimates existing home sales in 2009 were around 5.1 million units, close to 2000 levels. Housing starts, as estimated by the U.S. Census Bureau, were 553,000 in 2009, down from a high of 2 million in 2005.
Through this downturn, many private companies have gone bust, and even the stronger publicly traded firms have written off half or more of their book equity since the peak. But homebuilders that have survived are now standing on more-stable financial ground. Thanks to stimulus-related initiatives from 2009, such as the first-time homebuyers credit and longer tax-loss carry backs for U.S. corporations, homebuilders have been able to improve their businesses and their balance sheets over the last few years.
In the near term, high levels of unemployment and ongoing foreclosures remain significant head winds for the housing industry. It is also important to recognize the role of government involvement in the industry over the last year and the potential effects of its inevitable exit strategy. Since January 2009, the Fed and the Treasury have purchased about $1 trillion in mortgage-backed securities in an effort to hold down interest rates. When this program ends in March, interest rates are expected to rise. The $8,000 tax credit for first-time homebuyers, which was created in 2009, will also end soon in April. And finally, we highlight that future foreclosures could be a significant drag on housing prices. While some experts estimate future foreclosures to be as high as 7 million homes, others say the figure could be a lot smaller.
Downturns eventually run their course, and housing starts remain well below even typical trough levels, which should support a more favorable supply-and-demand picture in the future. By aggressively reducing inventory and ratcheting back on developments, many of the large homebuilders are now sitting on piles of cash, despite the heavy losses they have taken in recent years. They have also downsized their organizations to better align their cost structures for a lower-demand environment.
Still, homebuilding is far from "moaty." The industry has very low barriers to entry, and many firms hold significant land banks on their balance sheets, which can tie up large amounts of capital for long periods of time.
John Gabriel is an ETF analyst with Morningstar and contributor to Morningstar's ETFInvestor newsletter.
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