By: Larry MacDonald
There is now an exchange-traded fund (ETF) tracking airline stocks. Launched in January, it is called the Claymore/NYSE Arca Airline ETF (symbol FAA). The annual expense ratio is 0.65%.
Legendary investor Jim Rogers recently told reporters he is bullish on the airline industry. The many bankruptcies, cutbacks, and mergers are a sign of a bottom, he says. The industry has cleaned up the overcapacity problem that has made it such a bad investment over the last 10 years (during which the AMEX Airline Index has lost 90% of its value).
Meanwhile, the plunge in oil prices has lowered fuel costs substantially. One analyst estimates that the top ten airlines will save about $20 billion (US) in 2009, which more than offsets the $6- to $8-billion (US) hit to revenues expected from the recession.
Companies are admitted into the Claymore/NYSE Arca Airline ETF if they have at least half their sales from flying passengers, a market capitalization greater than $100 million (US) and daily trading volumes averaging at least $1 million (US) a day. On this basis, 25 companies presently make it into the ETF.
The weighting formula starts off with a 70% allocation to U.S. stocks and 30% to non-U.S. stocks. The top three U.S. carriers (by market cap), Continental, Southwest, and AMR, each get 15%. The top three international carriers, Lufthansa, Singapore Airlines and Air France, get 4.5% each. Rebalancing is done quarterly.
This will be a volatile ETF. Still, there is potential for more than a doubling in value. Maybe it could be a pick for the aggressive investor with a mad-money portfolio in or outside a TFSA?
7 Responses to “ Airlines ready for takeoff? ”
IMO, this has got to be the dumbest idea for a ETF (for an investor, not the promoter). That’s saying something, considering we have ETFs tracking agriculture, nano technology, Wal-Mart suppliers etc. The airline industry is notorious for losing money — lots of it. So much that Warren Buffett is fond of saying that capitalists would have been done a huge favour if the Wright brothers had been shot at Kitty Hawk. The fundamentals of the industry are terrible — huge capital costs, volatile operating costs and extremely sensitive to economic conditions.
By Canadian Capitalist on Feb 4, 2009
CC
1. Someone bullish on the airlines might say they are engaging in value investing (the conditions causing past underperformance have cleared-up substantially).
2. Passive index investors in the Bogle mode of course don’t like sector ETFs. But other investors will appreciate them (although not necessarily as long-term holds) as part of the “explore” component of their core portfolios. Of course, users of sector ETFs could harm their portfolio return with them. But they are willing to take that risk for a chance to earn higher returns. IMO, as long as one is fully aware of what they are doing, that’s not dumb but a difference in risk preferences. Here’s William Bernstein making a similar point in Four Pillars of Investing: “…there is one legitimate criticism that can be leveled at an indexing strategy: You will never have exceptional returns; you will never get fabulously rich. As we have already discussed, poorly diversified strategies do indeed maximize your chances of winding up with bags of money. Unfortunately, they also maximize your chances of ending up in a trailer park. Giving up a shot at the brass ring does bother a lot of investors.”
LM
By Larry MacDonald on Feb 4, 2009
This is a good ETF for people who want their money to go sideways for the next century.
By Patrick on Feb 4, 2009
I understand that some investors might want to play the long shot (hopefully with a tiny portion of their portfolio). That’s fine. If I recall correctly, SouthWest would have made an investor fabulously rich (ironic considering how poorly the sector has done). But my opinion is a sector ETF in airlines is a poor way of playing that game because I don’t see how the fundamentals for the sector has changed today; it’s a different story if we are talking about an individual stock in the airline industry, which might go on to become a multi-bagger.
By Canadian Capitalist on Feb 4, 2009
Patrick
The airline ETF wouldn’t be a long term hold (certainly not for a century). Could be a year or so …. If the industry is still being disciplined on how much supply is being put on the market, then might go a bit longer.
CC
According to many analysts (not just Jim Rogers) who follow the airline industry, the fundamentals are much better now. They say bankruptcies etc. have reined in the problem of oversupply for the time being. Savings in fuel costs are also expected to offset revenue losses. But I personally would prefer the ETF over a stock because it diversifies away stock-specific risk. Anyway, it shall be interesting to see how it turns out over the next year or so. Shall a beer be wagered over the outcome?
By Larry MacDonald on Feb 5, 2009
Reading my first comment again, I think using “dumbest” was not a nice way of putting it. I think “one of the worst” would have been better.
Larry, I’d be happy to wager a beer over the outcome, though if history is any guide, I’d be darned if I can get these short-term moves right. FAA is today trading at $20.90 and S&P is at 844.
By Canadian Capitalist on Feb 5, 2009
CC
Perhaps we should be clear about the outcome wagered over. I was thinking a gain 25% or more would be the criterion. Still interested?
By Larry MacDonald on Feb 7, 2009