Is XHB a Better Housing ETF Play?

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Despite some sluggish employment growth, the all-important housing market appears to be back on track. The segment has been soaring higher all year as great data has come in regarding a number of key housing stats, adding optimism to the sector.

Also, the Federal Reserve’s lax policies have further stimulated demand by keeping interest rates low and buying up MBS to ensure a liquid and cheap mortgage market. If that wasn’t enough, consumer confidence is at a post-recession high suggesting that many are finally starting to feel better about their economic situation (read Best Construction ETF to Ride the Housing Upswing?).

With this backdrop, housing focused investments have been fantastic for much of 2012. Many stocks in this corner of the equity world have crushed broad benchmarks and have risen significantly off of their subprime-induced lows.

In fact, the iShares Dow Jones US Home Construction ETF (ITB) has been among the best unleveraged ETF performers in the entire market this year. Since the start of 2012, ITB has added more than 67%, easily beating out the S&P 500 over the same time frame as the benchmark was ‘only’ able to muster a 10% gain in the same time period.

If that impressive long term performance wasn’t enough, investors should also note that the ETF has added over 35% in the past six months and 15% in the past quarter, suggesting that the strength has been ongoing throughout the year. No wonder the ETF has earned a Zacks ETF Rank of 1 or ‘Strong Buy’ and has been classified as such for quite some time now (read Four ETFs Up More Than 30% YTD).

Yet as incredible as this housing rebound has been, one has to wonder if the space is starting to get into overbought territory, at least in the near term. ITB has suffered a pretty significant sell-off in November, although it bounced back quickly, so there could be some more tax-selling in the underlying securities if a fiscal cliff compromise is not reached.

The housing boom story—at least from the builders’ perspective—could be getting a little overheated as well. It is still somewhat hard to believe that the housing market is entirely back on track given the issues with shadow inventory and weak job growth still hanging over the overall market.

At the same time, builders could still have plenty of room to run in order to get back to something close to pre-recessionary levels so it is hard to argue for entirely abandoning the sector at this time, especially when there are still some solid data points to underline the sector (also see Three Low Beta Sector ETFs).

This could mean that it is time to look at another housing ETF play instead that may be better positioned for the ‘second leg’ up in the housing swing. This ETF is the SPDR S&P Homebuilders ETF (XHB), and while it shares some similarities with its iShares counterpart, there are a host of differences as well.

First off, XHB is a tad older and has a bit more in volume and AUM. Additionally, XHB also sports a lower expense ratio than its counterpart, at just 35 basis points a year compared to 47 for ITB. This means that XHB will probably have a tighter bid ask spread and thus is almost guaranteed to have a lower total cost than ITB.

Beyond these structural differences, investors should note that although XHB has a better yield, the fund has greatly underperformed its counterpart in a year-to-date look. XHB has added ‘only’ 50% in the YTD time frame, which is obviously still respectable, but nothing compared to ITB’s nearly 70% gain (see Two ETFs that Have Surged from Their Lows).

This enormous differential has shrunk to practically nothing in the trailing three month period though, as ITB has just barely outperformed its State Street counterpart, suggesting that XHB could be on the right track heading into the final part of the year. Personally, I believe that this shift in the housing ETF market could be due to how different the two funds’ holdings are, and this reason could be why XHB may take leadership from ITB heading into 2013.

This is because ITB is entirely focused on homebuilders—like Pulte and Lennar—while XHB has a much more holistic approach to the space. This may come as somewhat of a surprise given that both ITB and XHB have similar names for their funds, but XHB actually puts just about a quarter of its assets in home builders and another 30% in building materials.

The rest of XHB hones in on household appliance makers and retail firms, giving the fund a very different holdings picture. In fact, Whirlpool and Lowe’s are the two biggest holdings in the fund at time of writing, while Lennar and Pulte don’t crack the top ten.

While this different focus has clearly been to the fund’s detriment to start the year, it could actually help XHB as we turn the calendar over. That is because many of the ‘discretionary’ sections of the homebuilder industry have not seen their prices surge by as much as their builder counterparts have. 

Thanks to this, these retail-type firms are arguably better positioned and are trading at more reasonable valuations as well. If that wasn’t enough, the aforementioned consumer strength could help these stocks anyway—irrespective of housing—suggesting that if current trends hold this could be the way to go instead (also see Biotech ETFs: A Fiscal Cliff Safe Haven?).

Plus you still get some ‘pure’ homebuilder exposure in XHB so you won’t be missing out if that segment continues to soar heading into the new year. So for investors considering a housing play but are worried about valuation levels, take a closer look at XHB. The fund could be a more fairly valued way to target the space that still has a great deal of upside thanks to some of the key trends hitting the consumer this quarter.

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