Aerospace and defense exchange-traded funds are hot thanks to a solid global economy, a stable outlook for the commercial airline industry and a ramping up of military budgets globally.
Four ETFs follow the sector: the iShares U.S. Aerospace & Defense ETF (ITA), SPDR S&P Aerospace & Defense ETF (XAR) and PowerShares Aerospace & Defense Portfolio (PPA) all have lengthy track records, while the Direxion Daily Aerospace & Defense Bull 3X Shares (DFEN) is a three-times leverage fund that launched last year.
These funds all outpaced the broader stock market in 2017, and the party has carried over into this year with gains ranging from 5 percent to 7 percent among the three unleveraged funds, versus the 1.7 percent gain in the SPDR S&P 500 ETF Trust (SPY).
A Moody’s research note says the outlook for the global passenger airline industry is stable based on expectations for steady operating profit margins over the next 12 to 18 months, with low- to mid-single digit revenue growth helping to offset modest cost pressures.
But it’s the jump in military spending that fuels these ETFs’ gains. Jane’s 360, a publication that follows the defense industry, said in December that global defense spending will grow for the fifth consecutive year, reaching $1.67 trillion in 2018 and overtaking the previous post-Cold War record of $1.63 trillion in 2010. Defense spending will increase by 3.3 percent in 2018, which Jane’s says is the fastest growth rate in a decade in part because of the largest year-on-year increase in U.S. spending since 2008.
Because aerospace and defense is a niche area, these ETFs have similar holdings and are almost exclusively focused on the U.S., but their approaches are slightly different.
The biggest by assets under management is ITA, with $5.86 billion. It follows the Dow Jones U.S. Select Aerospace & Defense Index and has an expense ratio of 44 basis points. It’s up 6.9 percent year-to-date, and boasts a one-year return of 35.12 percent and a 10-year return of 13.9 percent.
ITA takes a market-weight approach, and its top three holdings are Boeing at 12.1 percent, Lockheed Martin at 7.8 percent and United Technologies at 7.8 percent.
PPA appears similar to ITA with its market-cap weighted approach, and two of its top three holdings are the same: Boeing at 7.7 percent, Lockheed Martin at 7.3 percent and Honeywell International at 6.5 percent. It follows the SPADE Defense Index, and is the priciest with an expense ratio of 61 basis points. It has $992 million in AUM and has returned 7.1 percent year-to-date. It's up 33 percent on a one-year basis and 12.2 percent on a 10-year basis.
The least expensive of the three unlevered funds is XAR, with an expense ratio of 35 basis points and AUM of $1.2 billion. It’s an equal-weight fund with large and mid caps each comprising 40 percent of the portfolio, and small caps at 20 percent. It has a year-to-date return of 5.1 percent, a one-year return of 30 percent and a five-year return of 23.3 percent. (It launched in 2011, whereas PPA debuted in 2005 and ITA in 2006.)