Defense and the Dollar: Consumer Staples ETFs

• By Jonathan Bernstein, ETFzone.com Contributing Editor
• On 11:30 pm EDT, Thursday October 29, 2009

In good times and bad, consumers buy razor blades, toothpaste, laundry detergent, and soda pop. Consumer staples ETFs hold companies that produce or sell these daily necessities and are considered defensive. They have low volatility and low beta when compared to the benchmark S&P 500.

Consumer staples have historically been popular with investors seeking reliable earnings.The consumer staples sector is often grouped together with healthcare and utilities because they all generate reliable earnings and pay strong dividends. The chart below compares the Consumer Staples Sector SPDR (NYSEArca:XLP - News), a healthcare fund, Vanguard Healthcare (NYSEArca:VHT - News) and the utility Select sector SPDR (NYSEArca: XLU - News) with the benchmark Standard and Poors Depositary Receipts (NYSEARca:SPY - News).

During the market turmoil of 2008 and 2009, Consumer Staples fund XLP, though well-correlated with the benchmark SPY, fell less dramatically and has more quickly retained its pre-crisis level than the benchmark. On the 3-year basis shown in the chart, consumer staples are less volatile than healthcare (VHT) and utilities (XLU). The consumer staples sector has historically outperformed in lackluster sideways markets when companies have trouble growing earnings.

Consumer staples ETFs, like other non-cyclical funds, historically have underperformed in recovery markets and during booms. In the chart below comparing XLP with the Consumer Discretionary SPDR (NYSEArca:XLY - News) and the benchmark SPY illustrates this.

The chart above is the textbook pattern for consumer sector performance during a recovery: the low-risk low-return consumer staples XLP lagging the benchmark SPY, which in turn lags the higher-risk, higher-return consumer discretionary XLY.

The strength of the dollar is increasingly important to the Consumer Staples ETFs. The largest company in the Consumer staples benchmark XLP is Procter and Gamble (NYSE:PG - News), which represents over 15% of the total fund. P & G gets almost 60% of its revenue from overseas, half of that from emerging markets. Companies like Colgate get almost three quarters of their revenue from abroad and about 50% from emerging markets. Another big holding, Kimberly Clark (NYSE:KMB - News) receives over 60% of its revenue from overseas and about 40% from emerging market countries. A weaker dollar helps to drive sales of consumer staples abroad.

There are several consumer staples ETFs, but the most basic are XLP, Vanguard Consumer Staples ETF (NYSEArca:VDC - News), iShares S&P Global Consumers Staples Sector Index Fund (NYSEArca:KXI - News). XLP is typical of the plain vanilla variety of consumer staples ETFs built to track popular indexes. The first consumer staples ETF to market, XLP commands the lion's share of investor capital (over 2 billion). XLP has a low expense ratio and very low turnover. Like other ETFs in this sector, XLP has historically posted strong yields had strong yields, a natural and important measure of steady income for investors. XLP is heavily concentrated in Proctor and Gamble (NYSE:PG - News) and Walmart (NYSE:WMT - News) and Phillip Morris International (NYSEArca:PM - News). Together they represent over a third of the fund's total holdings.

Comparable is Vanguard's VDC, designed to track the performance of the MSCI U.S. Investable Market Consumer Staples index. It has a slightly lower expense ratio, but a much higher turnover than XLP. Though somewhat more diversified-- its largest allocations include in addition to PG, WMT, and PM are Coca-Cola (NYSE:KO - News) and Pepsi (NYSE:PEP - News). Top-ten holdings in both of these ETFs represent over 60% of total assets. Somewhat more diversified and the smallest by capital of the three is KXI. Top ten allocations tend to comprise about 50% of this ETF.

In addition to the plain vanilla consumer staples ETFs, there are several fundamental funds in this category which seek to beat the standard indexes:

• First Trust Consumer Staples AlphaDEX Fund (NYSEArca:FXG - News)
• Powershares Dynamic Consumer Staples Sector Portfolio ETF (NYSEArca:PSL - News)
• Rydex S&P Equal Weight Consumer Staples ETF (NYSEArca:RHS - News)

These funds are truly tiny compared to the plain vanilla funds. The reason for this is partly historical: they are newer than the first three ETFs above. These funds garner investor attention by taking a strategic approach to consumer staples sector allocation. The value of these strategies are dubious. What is clear is that these strategies add cost to fund administration. As a result these funds tend to have higher expense ratios and often higher turnover. FXG for example has an expense ratio of 0.70% and an annual turnover of close to about 95%. RHS is an equal weight fund. Its expense ratio is 0.50% and an annual turnover of 19%. PSL comes in at 0.65% with an annual turnover ratio of 44%. PSL currently has very small volume and there is risk of the fund's closure. From an expense ratio perspective, these are not necessarily unreasonable, nor are these turnover rates necessarily excessive. All are lower than typical mutual funds in this category. However historical returns don't seem to justify these higher costs to investors.

There are a few other ETFs in this category worthy of mention. The first is a subsector of the consumers staples fund: the PowerShares Dynamic Food & Beverage (NYSEArca:PBJ - News), which is has attracted a lot of interest since its inception in mid-1995. As might be expected, this ETF has more exposure to food companies like General Mills (NYSE:GIS - News) and Heinz (NYSE:HNZ - News) than the broad-based staples ETFs mentioned above. Though PBJ has a higher expense ratio than the plain vanilla funds, we regard this as an attractive option for investors looking for a staples subsector fund.

Finally there is also a strictly international staples ETFs: WisdomTree International Consumer Non-Cyclical Fund (NYSEArca:DPN - News). This fund has failed to attract substantial capital to date and we believe the lack of investor interest suggests that it risks closure.

Consumer Staples ETFs and their expense ratios are listed below:

Broad Index Consumer Staples ETFs

• Vanguard Consumer Staples ETF (NYSEArca:VDC - News), 0.2%
• Consumer Staples Sector SPDR (NYSEArca:XLP - News), 0.22%
• iShares S&P Global Consumers Staples Sector Index Fund (NYSEArca:KXI - News), 0.48%

Fundamental Consumer Staples ETFs

• First Trust Consumer Staples AlphaDEX Fund (NYSEArca:FXG - News), 0.7%
• Powershares Dynamic Consumer Staples Sector Portfolio ETF (NYSEArca:PSL - News), 0.65%
• Rydex S&P Equal Weight Consumer Staples ETF (NYSEArca:RHS - News), 0.5%

Sub-Sector and International Consumer Staples ETFs

• PowerShares Dynamic Food & Beverage (NYSEArca:PBJ - News), 0.63%
• WisdomTree International Consumer Non-Cyclical Fund (NYSEArca:DPN - News), 0.58%

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds.

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