Look Under the Hood to Know Homebuilders ETFs

Takeaway:  ITB is a more concentrated ETF play than XHB regarding homebuilder companies.

Before I get to talking about homebuilder ETFs, here are a few words about the 2011 spring selling season for new homes. Not good. I see tepid demand with signs of modest traffic for new homes this season, and think prospective buyers are being cautious in most local markets. However, pricing trends appear to be firming or are not declining as much as was the case in 2010.

In April 2011, the National Association of Home Builders (NAHB) said homebuilders were competing against high numbers of foreclosed and distressed properties, which have been holding prices and appraisals down. This has made it challenging for prospective buyers to sell existing homes.

A pocket of strength I see is the lower priced house category, which generally serves first-time home buyers. These buyers have more flexibility than move-up or repeat buyers, who have to sell existing homes. Also, affordability has come from very attractive prices relative to historic levels and low mortgage rates. But I caution, you have to be able to meet the tighter credit guidelines.

Two weeks ago, the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) came out. This showed the index staying at 16. This is well below recovery levels, where measures above 50 indicate that more builders view sales conditions as good. Two of the three measures posted April declines.

According to HMI, the metric for current sales conditions fell one point to 16, while sales expectations for the next six months dropped three points to 23, its lowest level since October 2010. One bright spot was the index for traffic of prospective buyers, which rose a point to 13 in April, its highest level since June 2010.

Moving on to homebuilder ETFs, I have a neutral fundamental outlook for the homebuilding sub-industry. Assuming improved demand going into 2012 with price stability, I see most publicly traded builders in a favorable competitive position after reducing cost, retiring debt, and increasing cash positions over the past few years. Year to date through April 29, 2011, the S&P Homebuilding Index was up 3.7%, this compares to the consumer discretionary sector up 8%, and the S&P 1500 Index up 8.8%.

By reading the names of these two ETFs, most investors would think they directly play the homebuilders. However, it’s not that simple, and we explain below.

The iShares Dow Jones US Home Construction Index Fund (ITB 13 Underweight) has 28 holdings mostly related to homebuilder stocks. Where as the SPDR S&P Homebuilders ETF (XHB 18 Marketweight) has 35 holdings made up of a more diversified basket of building products, homebuilders, home furnishing retail, home furnishings manufacturers, and household appliance companies.

ITB uses the Dow Jones US Select Home Construction Index, while XHB applies the underlying holdings of the S&P Homebuilders Select Industry Index. We will look closer at the holdings, because the index does not provide a complete picture of what makes up each of these ETF securities.

Regarding top 10 ETF holdings, ITB has all ten holdings related to homebuilder stocks, which collectively represent 58% of the total ETF assets from holdings reported as of February 28, 2011, and with an S&P ranking as of May 4, 2011. The homebuilding stocks are 64% of the total ETF assets. Of the companies in the top 10, no stock is ranked 5-STARS (Strong Buy) by S&P, three are ranked 4-STARS (buy), two are ranked 3-STARS (hold), four are ranked 2-STARS (sell), and one is ranked 1-STARS (strong sell).

On the other hand, XHB’s home construction profile has only one homebuilder stock in its top ten holdings and the homebuilder stocks are only 28% of the total ETF assets reported as of March 31, 2011, and with an S&P ranking as of May 4, 2011. A year ago, the number of homebuilder stocks in the top ten was higher as a percentage of total ETF assets, but I think they may have underperformed other non-homebuilding stocks in XHB’s holdings.

The top 10 holdings for XHB were 38% of the total ETF assets. Of the companies, no stock is ranked 5-STARS (Strong Buy) by S&P, three are ranked 4-STARS (buy), four are ranked 3-STARS (hold), two are ranked 2-STARS (sell), no stock is ranked 1-STARS (strong sell), and one is not ranked.

For these ETFs, I would position ITB and XHB as tactical investments, versus core or strategic holdings in an investment portfolio. I see these being used to gain a more concentrated position to drive above market performance. As with all investments, I point out that investors should look to make selections that are suitable for their investment objectives and risk profile.

Positive Implications: SPDR S&P Homebuilders ETF (XHB 18.69 Marketweight)

Negatives Implications: iShares Dow Jones US Home Construction Index Fund (ITB 13.15 Underweight)

The posts on this blog are opinions, not advice.
Please read our disclaimers for Ratings Services, Indices, Equity Research, Securities Evaluations and Risk Solutions.

One Comment

  1. Arobindo Dutt says:

    Excellent information. Please continue to provide updated on the industry. I am inclined to think home building market to edgr up a notch during 2012 and may even take off a great dealin some market. Overall, I am positive on the industry and fill compelled to hold a small position soon.

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