Dissecting Two Retail ETFs

NEW YORK (TheStreet) -- In light of holiday shopping on Thanksgiving Day, the long-standing tradition of Black Friday and the newer tradition of Cyber Monday, investors will be thinking about investing in the retail industry and may look at the SPDR S&P Retail ETF (XRT).

Early reports from the National Retail Federation are that 141 million people shopped over Thanksgiving weekend this year compared with 139 million people last year but that the average spent fell to $407 from $423 last year. The Wall Street Journal cited a report from ShopperTrak that predicts this holiday season will be the worst since 2009.

A slowdown in holiday sales lends support to the idea that quantitative easing is losing its effectiveness. Holiday sales are very important to retailers, accounting for as much as 20% of the year's revenue according to that same Wall Street Journal article.

XRT has attracted $1.4 billion in assets and has rallied 41% in 2013, well ahead of the 27% logged for the S&P 500.

Apparel retailers such as the Men's Wearhouse ( MW) comprise 28% of XRT, followed by specialty retailers such as Vitamin Shoppe ( VSI) at 16% and automotive retailers at 13%. Internet retailers such as Amazon ( AMZN) and Expedia ( EXPE) account for another 10% of XRT.

XRT takes essentially no single stock risk. Its largest holdings have only about 1.5% weightings. It has 99 total holdings, charges an expense ratio of 0.35% and has a trailing dividend yield of 1.08%.

XRT is not the only retail exchanged-traded fund. The PowerShares Dynamic Retail Portfolio ( PMR) has actually been trading eight months longer than XRT, but with only $40 million, it has not gained anywhere near XRT's acceptance as a proxy for the group.

PMR has just 30 holdings, nine of which have between 4-6% weightings in the fund. A 5% weighting to a few stocks doesn't expose fund holders to unreasonable risk. PMR has a trailing yield of 1.92%, and the fund charges a higher expense ratio than XRT does at 0.74%

The funds have traded similarly this year with the slight performance advantage going to XRT's 41% to PMR's 39%.

The differences in the funds' compositions could result in more meaningful performance divergences. PMR allocates 48% to retailers such as Wal-Mart ( WMT) and Safeway ( SWY), whereas XRT allocates only 8.2% to these types of retailers. The distinction is that sales at a supermarket or drugstore will be less volatile during an economic downturn than sales at more discretionary retailers, which make up a larger part of XRT.

Also adding to XRT's volatility is its larger exposure to online retailers. PMR has just 6% allocated to Internet stocks, half of that to Internet service provider United Online ( UNTD), a relatively stable business since customers are less likely to cut off their Internet access during tough times than, say, to book a vacation online.

The differences should make PMR less volatile which has been the case most of the time. Lower volatility helps relative performance when the market goes down but is a drag during up markets.

XRT's peak-to-trough decline during the last bear market was 64%, compared with just 51% for PMR. Since that trough, however, XRT is up 378%, compared with 209% for PMR.

Concluding that one retail stock ETF is better than the other is the wrong framework. Each fund has different attributes, and the patterns of PMR going down less during large declines and XRT going up more during up markets is likely to repeat in future cycles because the characteristics of staples products and discretionary products.

An investor willing to invest as narrowly as to own a sector or industry fund could easily rotate into PMR after a huge rally like we've had and then back into XRT after a large, panic-inducing decline. XRT may have a while to run, but after it has gone up 300% in four years, it makes sense to think about rotating into a less volatile fund.

At the time of publication, the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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