In investing, what is comfortable is rarely profitable. — Robert Arnott.
While I am a fan of the argument that commodities as an asset class are due for a multi-year cycle of outperformance against equities, getting exposure to that through stocks in the materials sector doesn’t quite seem the right way to do it. The Materials Select Sector SPDR® Fund ETF (NYSEARCA:XLB) is an exchange-traded fund, or ETF, that seeks to mimic the price and yield performance of the Materials Select Sector Index. This index is an effective representation of the materials sector of the S&P 500 Index (SP500).
The primary goal of XLB is to offer precise exposure to companies in the chemical, construction material, containers and packaging, metals and mining, and paper and forest products industries. This allows investors to take strategic or tactical positions at a more targeted level than traditional style-based investing.
XLB is a passively managed fund that follows the index through a sampling methodology. This approach involves holding a range of securities that, in aggregate, approximates the full index in terms of key risk factors and other characteristics. This approach can cause the fund to experience tracking errors relative to the performance of the index.
XLB’s Portfolio Composition
XLB’s portfolio is primarily concentrated in the Chemicals industry, which accounts for approximately 68% of the fund’s total assets. This industry has demonstrated resilience amidst market volatility, consistently delivering strong earnings growth. In contrast, the Metals & Mining industry, which has been grappling with volatile commodity prices, constitutes a smaller portion of the portfolio.
The fund’s top three holdings include Linde plc, Air Products and Chemicals Inc., and Sherwin-Williams Company. These companies, particularly Linde plc, which accounts for about 20% of the fund’s total assets, have shown strong revenue and earnings growth trends.
The fund also has exposure to the Containers & Packaging and Construction Materials industries. Companies in these sectors typically have stable business models and strong cash generation potential due to their exposure to a wide array of end markets.
Performance Analysis
The unfortunate reality when it comes to the sector’s performance is that despite some momentary glimpses of relative strength, it’s broadly lagged the SPDR® S&P 500 ETF Trust (SPY). When we look at XLB relative to SPY, we can see sector investing here has been disappointing.
Evaluating Costs
When investing in passive ETFs, understanding the associated costs is vital. The annual operating expenses for XLB are 0.10%, making it one of the least expensive products in the space. These expenses include management fees, administrative fees, and other operational costs. This low expense ratio is an attractive feature for investors seeking cost-efficient exposure to the Materials sector.
Peer Comparison
When considering an investment in XLB, it’s useful to compare it with similar ETFs in the space. The big takeaway when looking at other ETFs in the space is that XLB is heavily dependent on the Chemicals industry performing well, while other Materials funds are more specific to mining. In other words, the real question isn’t how commodities would fare or even metals and mining with XLB, but rather how Chemicals fare going forward given its comparatively larger allocation there.
Conclusion
The Materials Select Sector SPDR® Fund ETF provides an avenue for investors seeking targeted exposure to the Materials sector. While the fund has demonstrated solid performance and offers a low-cost structure, upcoming economic headwinds, particularly coming out of China, could pose challenges. I’m personally indifferent to the sector here and think there are better opportunities elsewhere.
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