Some sectors are not geared toward all investors. The materials sector, the smallest sector weight in the S&P 500 Index at just 2.73%, is one of those groups. But the materials’ size in the S&P 500 and other broad benchmarks is not the issue. Rather, materials is a cyclical sector, meaning its volatility can be more comparable to other cyclical groups, such as energy and industrials.
Materials stocks often show correlations to commodities prices, making the sector vulnerable to swings in the dollar and the global economic cycle. Said simply, the materials sector is not a defensive sector.
Additionally, the materials sector is unlikely to weather broader market declines. If anything, the sector is likely to perform worse than the broader market during bearish environments. As broader benchmarks slipped last year, the Materials Select Sector Index tumbled nearly 15% for the year, or more than triple the 2018 loss incurred by the S&P 500.
For the adventurous and risk-tolerant, exchange-traded funds (ETFs) might be the way to go about picking stocks in the materials sector. Here are some of the best materials ETFs to invest in if the sector bounces back.
Materials Select Sector SPDR (XLB)
Expense ratio: 0.13% per year, or $13 on a $10,000 investment.
The Materials Select Sector SPDR (NYSEARCA:XLB) tracks the aforementioned Materials Select Sector Index and is the largest materials ETF in the U.S.
XLB, which is more than 20 years old, “seeks to provide precise exposure to companies in the chemical, construction material, containers and packaging, metals and mining, and paper and forest products industries,” according to State Street.
As a cap-weighted ETF tracking a relatively small sector, there is some concentration risk with this materials ETF. Just two stocks – DowDuPont Inc. (NYSE:DWDP) and Linde Plc (NYSE:LIN) – combine for over 36% of XLB’s roster. Overall, this materials ETF holds 25 stocks.
Fidelity MSCI Materials ETF (FMAT)
Expense ratio: 0.084% per year
Keeping with Fidelity’s rapidly growing tradition of being a low-cost leader, the Fidelity MSCI Materials ETF (NYSEARCA:FMAT) is the currently the cheapest materials ETF on the market. Like XLB, FMAT is a cap-weighted materials ETF.
That does not mean the returns generated by these two rivals will mirror each other. FMAT holds nearly 120 stocks, giving it a significantly larger lineup than XLB, meaning these materials ETFs are likely to offer varying returns from year-to-year. That was the case in 2018 when FMAT slid 17.40%, a performance that was 250 basis points worse than XLB’s.
Like the rival XLB, FMAT is top heavy, allocating over 37% of its combined weight to DowDuPont and Linde.
Invesco S&P 500 Equal Weight Materials ETF (RTM)
Expense ratio: 0.40% per year
For investors looking to mitigate the single stock risk often associated with the materials sector the Invesco S&P 500 Equal Weight Materials ETF (NYSEARCA:RTM) is the materials ETF to consider.
Regardless of sector, equal-weight ETFs typically feature smaller average market values among the underlying holdings than cap-weighted funds. The average market capitalization of RTM’s 25 holdings is $25.69 billion compared to $48.33 billion for XLB’s holdings. Despite the tilt toward smaller companies, that trait does not ensure RTM will perform worse than cap-weighted rivals when the materials sector slides. Last year, RTM actually performed slightly less poorly than the cap-weighted XLB and FMAT.
RTM also has a value feel as over 51% of this materials ETF’s holdings are classified as value stocks. None of RTM’s holdings have weights exceeding 4.30%.
SPDR S&P Metals & Mining ETF (XME)
Expense ratio: 0.35% per year
The SPDR S&P Metals & Mining ETF (NYSEARCA:XME) is a more tactical materials ETF, offering investors the potential for larger rewards – and greater risk – than rival materials ETFs.
Home to nearly $512 million in assets under management, XME “seeks to provide exposure to the metals & mining segment of the S&P TMI, which comprises the following sub-industries: Aluminum, Coal & Consumable Fuels, Copper, Diversified Metals & Mining, Gold, Precious Metals & Minerals, Silver, and Steel,” according to State Street.
XME is also an equal-weight ETF and its 29 holdings definitely toward the smaller end of the market capitalization spectrum as evidenced by an average market value of $4.64 billion. This materials ETF is heavily allocated to steel, coal and aluminum producers.
Those are volatile corners of the materials sector, meaning XME cannot endure simultaneous weakness in those industries. XME’s vulnerabilities to weakness in those segments was on display last year when the materials ETFs shed almost 27%.
First Trust Materials AlphaDEX Fund (FXZ)
Expense ratio: 0.64% per year
Beyond the equal-weight materials ETFs highlighted here, there are other smart beta approaches to this sector. The First Trust Materials AlphaDEX Fund (NYSEARCA:FXZ) is one of those funds. FXZ follows the StrataQuant Materials Index.
That index targets materials names from the Russell 1000 Index based “on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets,” according to First Trust.
FXZ’s weighting scheme is undoubtedly unique relative to other materials ETFs and its annual fee is undoubtedly high compared to the category average. Neither trait means FXZ is a “good” materials ETF as highlighted by the fund’s 2018 decline of 22.60%.
FXZ holds 51 stocks with a median market value of $6.89 billion and this materials ETF trades at steep discounts relative to the broader market as highlighted by a price-to-earnings ratio of just over nine.
Todd Shriber does not own any of the aforementioned securities.
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