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New ETF Hits Gold in Materials Sector

Roger Nusbaum

I was generally negative when I wrote about the materials-sector ETFs last year, as I thought they were too heavy in chemical companies and too light in mining stocks and yield. In addition, the funds owned U.S. stocks only, lacking vital international exposure.

My outlook has changed, mainly because iShares launched the iShares S&P Global Materials Index(MXI Quote) fund last week. After some examination, it appears that this is a way for investors to gain exposure to the materials sector without taking on the risk that comes with owning an individual stock.

Rectifying the international shortcoming, foreign stocks make up 76% of MXI's portfolio, with the U.K. (16%), Japan (12%) and Canada and Australia (9% each) holding the top international spots. U.S. companies weigh in at 24%.

MXI's subsector makeup is roughly 30% miners, 33% chemicals, 17% steel and aluminum and 14% in things like paper, wallboard and cement. The rest of the fund is a mix of other materials-sector components, such as potash and cellulose.

Mining Is Key

The 30% in mining is much more of that subsector than you'll find in MXI's domestic cousins. For comparison, the Material Sector SPDR(XLB Quote) has 13% of its holdings in metals and mining, while the Vanguard Basic Materials ETF(VAW Quote) has 7% and the iShares DJ Materials Index(IYM Quote) fund has 13%.

Simply put, MXI, through its strategy of increasing exposure to mining and mining services companies, appears to offer a more diversified approach to the materials sector and stands a better chance of taking advantage of future sector uptrends.

Need an example? When I wrote about XLB, VAW and IYM in 2005, my concern was that the funds would not allow holders to capture a big move in gold or the mining stocks, and that is exactly how it played out last spring.

Missing Out XLB lagged gold, mining

Using the streetTRACKS Gold Trust(GLD Quote) to show the timing of the lift earlier this year; BHP Billiton(BHP Quote), the largest holding in MXI, as a proxy for the mining group; and XLB as a representative of the domestic-materials ETFs, we can see in the chart above that XLB missed out on that uptrend due to its lack of mining exposure.

A U.S. Shortcoming

Part of the problem, of course, is that there are fewer mining stocks in the U.S. than in other countries, such as Canada, Australia and the U.K.

Despite being such a small portion of the market -- less than 3% of the S&P 500 -- the materials sector can be complicated. (We saw firsthand last summer -- in the wake of hurricanes Katrina and Rita -- how leveraged the chemical companies are to the price of oil.)

In addition, you don't need to be an expert in the sector to know that mining shares tend to be volatile and that picking the "wrong" name in the group can be very damaging to your portfolio.

As a consequnce, investors who until now relied solely on one of the earlier ETFs for exposure to the sector may very well have sat out the vast majority of the mining rallies of the last couple of years.

MXI, by having about one-third of its holdings in the mining group, clearly provides better diversification within the materials sector and is a more complete product.

Finally, there has been a lot of chatter on the Internet about there being too many ETFs, or that many of the ETFs are useless, and my contention all along has been that the "too many" contingent misses the point.

The future will bring a lot of new ETFs, and most of them will probably not have much utility, but I predict that 10% to 20% of them will bring something innovative and useful to the table, and MXI is an example of that.