Transportation ETFs Take Off

Transportation ETFs and mutual offs could be a good bet as travelers takes to the skies over the summer.
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NEW YORK (TheStreet) -- Transportation ETFs and mutual funds are beating the S&P 500 Index by a wide margin in 2010 thanks in part to strength in the airline sector.

The summer vacation season is upon us and droves of tourists from all corners of the globe will soon be taking to the skies in an effort to escape the nine-to-five and take advantage of a little fun in the sun.

Over the next few months companies including

Delta

(DAL) - Get Report

,

Continental

(CAL) - Get Report

and

Southwest

(LUV) - Get Report

could prove to be a lucrative short-term investment.

ETF investors may find the

Claymore/NYSE Arca Airlines Index ETF

(FAA)

to be an ideal instrument for gaining exposure to the top airline players. Boasting names such as those listed above as well as a number of major international players including Lufthansa and Singapore Airlines, FAA is the only pure play airline ETF available to investors today.

That pure play has paid off in the past month, as FAA has managed to handily outperform the

S&P 500

.

Looking beyond the summer, however, it may not be all clear skies for FAA. On the contrary, a number of challenges threaten the strength of the airline industry.

Fundamentally, airlines will continue to face the same challenges they have faced since consumers first started taking to the skies. Although the fractional jet ownership company, NetJets, remains a branch under the

Berkshire Hathaway

(BRK.A) - Get Report

umbrella,

Warren Buffett

, when questioned in the past about airlines, has cited the industry with the makings of the worst kind of business.

Fuel prices, high fixed costs, labor unions and the fact that air traveling is heavily dependent on economic cycles have persistently thwarted the industry's ability to make money.

Furthermore, Mother Nature is presenting the airlines with yet another challenge in the form of an uptick in volcanic activity. Earlier this year, the Icelandic volcano, Eyjafjallajokull, put a freeze European air travel plans for a couple weeks. Although activity from this volcano has quieted in recent weeks and airlines have, for the most part, returned to business as usual, scientists continue to monitor the area, with particular interest paid to Katla, a considerably larger volcano also located in Southern Iceland. In recent weeks, this larger peak as shown signs of seismic activity and if it were to blow its top, the detrimental effects on airlines could be even more dramatic.

Ultimately, the fundamental and environmental challenges facing the airline industry are enough to dissuade me from encouraging investors to try their luck with FAA. Instead, investors interested in playing the airlines should turn to other popular transportation ETFs and mutual funds as a way to gain exposure to this subsector while mitigating sector specific risk.

The

iShares Dow Jones U.S. Transportation Average Index Fund

(IYT) - Get Report

splits the transportation industry into seven sections. Railroads, delivery services, and trucking firms each account for approximately 25% of the fund's portfolio. The airline industry commands an 8% slice of this fund.

The

Fidelity Select Transportation Portfolio

(FSRFX) - Get Report

, like IYT, takes a broad approach to the transportation industry, tracking truckers, railroads, marine transportation companies and airlines alike. However, unlike IYT, this fund allocates a considerably larger percentage of its portfolio to companies like DAL and LUV. These two firms alone account for over 9% of the fund's holdings.

During the past month, the mutual fund's heavier exposure to the airline industry has helped it overpower its ETF challenger, and in my firm's long-term momentum ranking system, FSRFX is currently the No. 1 ranked Fidelity Select fund.

Either FSRFX or IYT would make a good proxy play on the airline industry. However, choosing between the two ultimately depends on your risk tolerance. Airline bulls should go with FSRFX. Investors who are bearish on the airlines should go with IYT.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion Money Management was long Fidelity Select Transportation Portfolio.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.