Telecom exchange-traded funds have crumbled in 2008 as nearly every holding has been mired in the red.
But with such a small number of stocks in each fund's basket, it will likely take longer for investors in these sector-specific ETFs to see a bottom.
"The reality is that the telecoms tend to trade more or less with the market and at a higher beta
volatility," says Jason Browne, portfolio manager with DAL Investment. "When things are going up, they tend to do fairly well. When things are not going well, they tend to get beat up pretty good."
One reason for the funds' exaggerated moves is their relatively few holdings. "More than any other sector of the ETF market, these things are incredibly concentrated," says Matt Hougan, editor of
and IndexUniverse.com. "It really pays to know what you're buying."
A rebound in telecom ETFs essentially hinges on the recovery of two stocks:
. Every telecom-related fund invests in these two stocks and, in some cases, a large chunk of the holdings is dedicated to both companies.
For example, the
iShares Dow Jones U.S. Telecom Sector Index
Vanguard Telecom Services
ETFs have 37% and 39% of their portfolios, respectively, invested in AT&T and Verizon.
is even worse, with 81% of the fund in those two companies," says Hougan. "So regardless of whether the telecom sector recovers, what happens to these two companies could really determine what happens to your investment."
Indeed, as AT&T has fallen 22% for the year and Verizon has given back 18%, nearly every telecom ETF has dropped with them. The iShares Dow Jones U.S. Telecom Sector Index and the Vanguard Telecom Services are down 17% each in 2008 -- and the Telecom HOLDRs has slumped more than 21%.
"It's very hard to move the dial when you have two companies that are such big weights," says Charles Brown, vice president of investments of Johnson Illington Advisors. "Everything else is just incremental at the margins. Even if something smaller moves, it's not going to have that big of an impact on the ETF because AT&T and Verizon dominate the weightings of those ETFs."
It doesn't bode well then for either AT&T or Verizon, that Brown says he isn't enthusiastic about the prospects for the telecom industry. His firm's strategy requires it to own some telecom ETFs and shares of Verizon, despite his dour view.
"Verizon has been going around laying fiber optic cable, which was a very large capital expenditure for them," Brown says. "Verizon is closer to an inflection point than not, but it seems to be the dog with the least amount of fleas, if you will."
Brown's big-picture view of telecom is that it's a commodity product, making it hard to differentiate individual companies' offerings. "Additionally, competition keeps driving down the price. It's very hard to have any sort of competitive advantage in this industry," he adds.
For DAL Investment's Browne, expecting a turnaround now in telecom ETFs is akin to "trying to catch a falling knife. If I'm going to buy a sector fund right now, I'd feel a lot more comfortable waiting for a breakout rather than trying to catch that knife."
Like Hougan, who says that "ETFs are still the best way to play the category that I know of," Browne argues that buying telecom funds is a contrarian play right now. "There will be some time when telecoms will probably come back into favor, and the ETFs are as good a way to play them as any."
Of course, investors who can't stomach the prospect of waiting for the share prices of AT&T and Verizon to turn around have other ETF options in telecom. There is the
PowerShares Dynamic Telecom
ETF, which is more diversified than other telecom funds.
The diversification, though, comes at a price. "Only half the fund (52%) is actually invested in telecom," Hougan says. "The rest is invested in technology companies like
and TV providers like
Still, though, Browne says that nearly every telecom fund is treading a fine line between hold and sell. "They're not a screaming sell from my perspective, but they're not a buy," he says.