Pratt & Whitney, a division of United Technologies (NYSE:UTX), announced Jan. 10 that it had secured a $194 million contract from the Department of Defense to build engines for the F-35 stealth fighter. The announcement should reassure investors that top-line revenue growth at the company hasn’t evaporated despite defense spending cuts. But before running out to buy its stock, you might want to consider the alternatives.
No, I’m not talking about another stock, but rather an exchange-traded fund like the Industrial Select Sector SPDR (NYSE:XLI), which is managed by State Street Global Advisors, along with eight other Select Sector SPDRs. To date, State Street has gathered more than $20 billion in assets for the nine index funds that comprise the S&P 500. As the fund’s website states, “Select Sector SPDRs have the diversity of a mutual fund, the focus of a sector fund, and the tradability of a stock.” All true. But why would someone who’s interested in owning United Technologies shares want to own a bundle of stocks instead? Read on and I’ll explain.
Anyone who buys United Technologies stock is getting arguably one of the best-run conglomerates in the country. In addition to Pratt & Whitney, its brands include Carrier, Otis and Sikorsky. All very well-known, the four combined for $42.6 billion in revenue in 2010. A $10,000 investment at the end of 2001 is now worth slightly less than $24,422 compared to $13,312 for the S&P 500. UTX currently yields 2.5% and is part of the Dividend Achievers index (companies increasing dividends in 10 or more consecutive years), it’s easy to see why someone would want to own its stock.
Unfortunately, the past doesn’t always predict the future. For this reason, some investors might be better served exploring a more diversified ETF alternative.
In terms of volume, the XLI is one of the top 20 ETFs, with an average daily volume of 16.9 million shares. More than 15% of its shares change hands on a daily basis. Liquidity is not a problem. Its net assets as of Dec. 31, 2011, were $2.71 billion. The fund has 61 holdings, with United Technologies being the third-largest at 5.39%. Its top 10 holdings represent 49.3% of the overall assets of the fund.
For those of you who like the 2.5% yield United Technologies offers, the ETF’s yield is similar, at 2.2%. From a performance perspective, the ETF unfortunately hasn’t come close to meeting the returns of United Technologies over the past decade, averaging 4.9% annually compared to 10.4% for the conglomerate. On the bright side, it did outperform the S&P 500 in the same time frame.
Because of this underperformance, I’ve widened my search to see if there’s something from an ETF perspective that fared better, is still broadly diversified and has United Technologies in the top 10 holdings. The only ETF that comes close is the SPDR Dow Jones Industrial Average ETF (NYSE:DIA), which seeks to provide results similar to the Dow Jones Industrial Average and has 32 holdings compared to 30 for the index itself. In terms of diversification, the 32 holdings cover all nine sectors, including industrials, which is the largest representation at 21.5% of the fund. United Technologies is the seventh-largest holding with a weighting of 4.66%. It’s as blue-chip as there is. Its 10-year annual return as of the end of December 2011 is 4.44%, 46 basis points less than the XLI. It’s a toss-up.
Those chasing performance at the expense of everything else, including risk, sometimes get stung. While a 550-basis-point difference in annual performance is definitely a big deal, it’s important to remember that investing in a single company without any consideration for diversification provides absolutely no protection against disaster.
If you like United Technologies as a company but don’t have the funds to buy 15 to 30 stocks equally as solid, both ETFs allow you to have your cake and eat it too. And there’s nothing wrong with that.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.