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Transport Funds Offer Route to Airlines

NEW YORK ( TheStreet) -- Southwest Airlines' (LUV) decision to acquire AirTran (AAI) follows on the heels of the announcement that Continental (CAL) was uniting with United (UAUA).

This boost in M&A activity within the airline industry may have investors eyeing the sector right now.

Unfortunately, the ETF that provides specific exposure to the industry, the Guggenheim Airline ETF (FAA), has a few flaws which make me hesitant towards recommending it for a long-term position.

For one, FAA spreads assets amongst its portfolio components a bit too unevenly for my taste. The fund, which until recently was known as the Claymore/NYSE Arca Global Airline ETF, devotes roughly 15% of net assets each to its top three holdings, Southwest Airlines, United and Delta Air Lines (DAL).

Also, despite being a global fund, FAA allocates a lopsided 72% of net assets to companies from the United States.

The final problem with FAA, and perhaps the greatest, is its low volume, which makes it vulnerable to volatility and tracking error.

Although investors have no other alternative fund that can be considered a pure play on the airline industry, there are ways to gain exposure to the sector through other products.

One option is to use iShares Dow Jones Transportation Average Index Fund (IYT). This fund tracks companies which represent multiple sub-sectors of the broad transportation industry.

The airline industry claims 8% of net assets in the ETF and the five companies represented in order of greatest exposure to least exposure are CAL, LUV, DAL, JetBlue (JBLU), and AMR (AMR).

In addition to the airline sector, companies from the railroad, marine, and trucking transportation sectors are all represented.

The best represented industries are railroads, delivery services, and trucking, which account for 28%, 23%, and 21% of the ETF's portfolio, respectively. Examples of companies from these three sectors, respectively, are Union Pacific (UNP), FedEx (FDX), and C.H. Robinson Worldwide (CHRW).

The sector diversification inherent of a fund like IYT will give investors greater stability in the face of market headwinds. The ample volume of the ETF will also allow investors to not be concerned about liquidity or tracking error.

While stable, with such a small portion of its index set aside for the airlines, investors specifically seeking exposure to the industry may be left wanting more. In this case, there is a transportation-focused mutual fund which allocates a greater portion of its portfolio to the airline industry.

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