Beware Faults in Homebuilding ETF

This column was originally published on RealMoney on Nov. 3 at 3:21 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

When I first started writing for RealMoney, a reader asked me if there was an exchange-traded fund for the homebuilding sector. There wasn't then, but there is now.

In the past few weeks, PowerShares has priced a basket of narrowly focused ETF products, including PowerShares Dynamic Building & Construction Portfolio(PKB Quote). (At this point, it is clear to me that PowerShares is making a greater commitment to differentiation than the other ETF providers. I'll review more of the PowerShares ETFs in future columns.)

Every investor, professional and do-it-yourselfer has at least one or two blind spots. The homebuilding sector is definitely one of mine, which is why I am writing about it first. I just don't understand how demand for new houses can perpetually increase, which is one of the reasons I've avoided investing in this sector.

Although this relatively new instrument is attractive, I'm steering clear of it, too. And investors who are interested in using this as a vehicle for shorting may come to the same conclusion because of some unusual dynamics that spring from an analysis of this ETF's makeup.

True to its name, the Building & Construction Portfolio is more than homebuilding, which represents 27% of the fund. Machinery and trucks comprise 16% of the fund and various types of materials make up 23%. These percentages may seem high, but remember that the B&CP, along with other sector-based ETFs, is trying to capture a narrow slice of the market. A homebuilding stock will be more volatile than the homebuilding sector, which will be more volatile than the broader market. An owner of this fund should expect B&CP to be more volatile than any broad index.

The B&CP's five largest holdings each comprise close to 5% of the fund:

• 5.1%: Georgia-Pacific(GP Quote)
• 5.1%: Caterpillar(CAT Quote)
• 4.9%: D.R. Horton(DHI Quote)
• 4.8%: KB Home(KBH Quote)
• 4.7%: American Standard(ASD Quote)

It is important to note that the above numbers are as of Sept. 30; the numbers currently given on the PowerShares Web site are as of June 30 and are quite different. In pursuit of better returns, PowerShares products mimic indices that have more turnover than most other indices; in this case, it's the Dynamic Building & Construction Intellidex, or DWC.

As you can see from the chart below, these five holdings have had a very volatile two months.

Wild Ride The five largest holdings have been volatile recently

Source: BigCharts.com