Exchange-traded funds have taken the market by storm, with more than $1.5 trillion in assets under management across more than 3,000 securities. These ETFs provide everyday investors with exposure to previously inaccessible corners of the market, while enabling them to build a diversified and low-fee stock portfolio both quickly and easily [see The Cheapest ETF for Every Investment Objective].
Consumer ETFs have become a popular way for investors to hedge a portfolio due to the relatively stable nature of consumer spending. For example, there’s little question that consumers will continue buying toilet paper from companies like Procter & Gamble Inc. (PG) or Kimberly Clark Corporation (KMB), even if the economy turns south.
What’s the Appeal?
Consumer spending drives approximately 70% of the U.S. gross domestic product (“GDP”), according to data from the World Bank, making consumer stocks an integral part of any diversified stock portfolio. But with so many moving parts within this segment of the equity universe, investors may want to use ETFs to simplify their exposure [see Consumer Centric ETFdb Portfolio].
For example, an investor may want to invest a quarter of their portfolio in consumer-focused equities. While large diversified consumer goods companies like Wal-Mart Stores Inc. (WMT) or Procter & Gamble are one option, the investor risks a downturn in any one of these stocks having a disproportionate impact on their overall portfolio – a risk that ETFs can mitigate.
Consumer Staples Vs. Discretionaries ETFs: What’s The Difference?
Consumer-focused equities can be broadly divided into two groups based on how “necessary” their products are to consumers – consumer staples and consumer discretionary. Generally speaking, investors can shift their portfolio between these groups depending on overall market conditions, with the former being a defensive play and the latter being a riskier play.
Here’s an overview of these two types of consumer equities and ETFs:
- Consumer staples are disposable products that consumers could not live without, such as toilet paper or groceries. Since consumers require these products regardless of the economy’s health, investors view consumer staples as a defensive investment. That is, they tend to attract investors when the economy is doing poorly, since they represent a safe-haven of sorts, but may underperform during a bullish market.
- Consumer discretionary companies sell products that consumers could live without, such as computers, automobiles or apparel. Since these products depend on how much extra money consumers have, they are considered cyclical investments by investors. That is, they tend to outperform when the economy is doing well and may suffer when there’s a downturn, given that their products are the first to be cut by consumers.
Finding Your Balance
Consumer staples and discretionary companies are dominated by a few large names, including Procter & Gamble, Phillip Morris and Coca-Cola, among others. Many consumer ETFs that base their weightings on market capitalization are therefore overweight in these names. For example, Procter & Gamble accounts for around 14% of the Consumer Staples Select Sector SPDR ETF (XLP, A+).
Here are some popular consumer ETFs for comparison, including some names that aren’t as overweight within any single equity:
|RCD||S&P 500 Equal Weight Consumer Discretionary ETF||82||13.91%||GameStop Corp (GME) – 1.57%|
|FXD||Consumer Discretionary AlphaDEX ETF||125||14.14%||Netflix Inc. (NFLX) – 1.52%|
|RHS||S&P 500 Equal Weight Consumer Staples ETF||41||26.49%||Walgreen Company (WAG) – 2.71%|
|XLP||Consumer Staples Select Sector SPDR ETF||41||64.95%||Procter & Gamble Inc. (PG) – 13.59%|
Data as of 6/11/2013
On a related note, investors should carefully consider the market capitalizations of companies held by these ETFs, which tend to be large-cap stocks. These large-cap companies may have less potential upside than small-cap companies (after all, it’s easier to double $10 million than $10 billion). As a result, investors may want to consider one of many small-cap consumer ETFs [Download 101 ETF Lessons Every Financial Advisor Should Learn].
Some popular options in this area include:
- PowerShares S&P Small-Cap Consumer Staples ETF (PSCC, B-)
- PowerShares S&P Small-Cap Consumer Discretionary ETF (PSCD, B+)
The Bottom Line
Consumer ETFs provide investors with a great way to build in exposure to the largest segments of the U.S. economy both quickly and easily. By using ETFs in lieu of large-cap stocks, investors can diversify their exposure to any individual company, while maintaining exposure to either consumers as a whole or niche consumer staples or consumer discretionary firms.
However, investors should be aware of the two different types of consumer ETFs–consumer staples and consumer discretionary–and their dynamics during different market conditions. And secondly, investors should carefully consider the weighting of individual stocks within ETFs to avoid unnecessary exposure to a single security.
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Disclosure: No positions at time of writing.
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