Aerospace and Defense ETF Investing 101

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The aerospace and defense sector found its largest base in the U.S. with a military budget fittingly impressive. The country's global leadership position requires it to maintain the capacity to respond to the ever-changing national security environment.

In Apr 2013, the Obama administration proposed a defense budget of $526.6 billion for FY14, down $0.9 billion from the FY13 annualized continuing resolution level of $527.5 billion.

The budget sequester that went into effect at the start of March 2013 and that has a direct bearing on the U.S. government's defense spending is a function of the country's fiscal and economic challenges. Sequestration will cut some $1 trillion from the defense budget over the next decade, according to The Washington Free Beacon. Yet, the aerospace and defense industry is holding up well this year thanks to technological innovations, big contracts, acquisitions and growing commercial demand. (Read: Silver ETFs Surge on Solid Industrial Demand)

ETF to Tap the Sector

The aerospace and defense sector has been performing well over the past three months, overcoming fears of government spending cuts and sequestration. Exchange traded funds (ETFs) like iShares US Aerospace and Defense (ITA) and PowerShares Aerospace and Defense (“PPA”) have provided returns of 10.18% and 8.91%, respectively, over the last 13 weeks (Read:3 Aerospace & Defense ETFs Defying Gravity). Investors have been pouring money in these stocks and ETFs over the past few months and the sector has significantly outperformed the broader market this year.

 

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. 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 & Defense sector in this particular case. The aerospace and defense stocks have performed well in the first half of the year and the benefits of the same have trickled down to the defense ETFs (Read: Play a Surging Defense Industry with These 3 ETFs).

 

 

 

iShares U.S. Aerospace & Defense ETF (ITA)

 

ITA tracks the Dow Jones U.S. Aerospace & Defense Index, providing exposure to companies related to the Aerospace and Defense industry. This index has 99.86% focus on U.S companies with the balance 0.14% on others. The index measures the performance of the aerospace and defense sector of the U.S. equity market.

 

The ETF launched in May 2006 presently has an asset base of $150 million. This fund holds 35 stocks and the top 10 companies hold a 56.29% share of total net assets.

 

The average daily volume is about 27,000 shares and the fund has an annual dividend yield of 1.11%.

 

Among individual holdings, top stocks in the ETF include United Technologies Corp., The Boeing Company and Precision Castparts Corp. comprising 9.09%, 8.67% and 6.48%, respectively, of total net assets.

 

Aerospace & Defense Profile (PPA)

 

This ETF tracks the SPADE Defense Index, holding 49 securities in its basket. 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 Oct 2005.

 

This index has 99.84% focus on U.S companies with the balance 0.16% on others. The fund so far has managed assets of $67 million. The top 10 companies hold a 53.01% share of total net assets. The average daily volume is about 32,234 shares and the fund has an annual dividend yield of 1.19%.

 

In terms of holdings, The Boeing Company, Honeywell International Inc. and United Technologies Corp. occupy the top three positions in the basket comprising 6.46%, 6.39% and 6.27%, respectively, of total net assets.

 

SPDR S&P Aerospace & Defense ETF (XAR) Profile

 

This fund follows the S&P Aerospace & Defense Select Industry Index. The Index represents 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.

 

With holdings of 35 stocks, top stocks in the ETF include TransDigm Group Inc., Alliant Techsystems Inc. and Precision Castparts Corp. comprising 4.53%, 4.45% and 4.41%, respectively, of total net assets.

 

Launched in Sep 2011, this index has 99.48% focus on U.S companies with the balance 0.52% on others.

 

The fund so far has managed assets of $20.7 million and the fund has an annual dividend yield of 1.51%. The top 10 companies hold a 43.78% share of total net assets. The average daily volume is about 2,617 shares.

 

To Sum Up

 

The aerospace & defense sector has been a keystone of the U.S. economy for decades and has provided well paying jobs for a variety of skill levels. However, the sector’s position is now challenged by global competition, changes in technology, national and worldwide economic conditions, and global policies affecting defense, civilian and commercial aviation.

Sequestration still remains an overhang both in the civil and military sectors. The companies that have little diversification outside the U.S. are highly susceptible to spending cuts from sequestration.

However, undeterred by defense budget cuts, the big defense operators are expanding their operations through acquisitions. Moreover, in order to counter the domestic headwinds, these players are looking for growth from international orders and are busy restructuring their businesses. Also, they are keeping themselves abreast in the technological front with new products countering fresh competition.

Keeping in mind the technological progress, acquisition benefits and cost-cutting efforts of individual companies, we have an overall bullish outlook for the sector.

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