What is the ‘Basic Materials Sector’? Here’s a good definition of this sector as provided by Investopedia: “The basic materials sector is a category of stocks for companies involved in the discovery, development and processing of raw materials. The sector includes the mining and refining of metals, chemical products and forestry products. The basic materials sector is sensitive to changes in the business cycle. Because companies in this sector supply materials for construction, they depend on a strong economy.
XLB vs S&P 500: January 1999 – April 2018
Source: https://www.portfoliovisualizer.com/
Okay, now we know what is in a typical Natural Resources fund, but are they worth considering for a long-term investment? Let’s first look at the oldest available ETF available in this sector, the Materials Select Sector SPDR® Fund (XLB). XLB has in fact done very well since its’ inception date of December 16, 1998. It has compounded at rate of 7.47% CAGR (compounded annual growth rate) versus an S&P 500 index fund which only produced 5.94% CAGR. An added benefit to this sector is its’ relatively low correlation coefficient of 0.79 to the U.S. Stock Market. With this evidence in hand, it is my opinion that the Natural Resources sector is a good place to consider investing some of our funds.
Now that we’ve determined that Natural Resources equities may be a good place to invest, let’s look at all the ETFs in this sector that have been available for ten years or longer. To rank all these ETFs, I compared each one against all the others utilizing the back-testing tools at portfoliovisualizer.com. As you may note, some of the lower ranked ETFs performed better during shorter time-frames, but this website is all about long-term investing and long-term performance, so I always compare funds back as far as I can get data, which is usually the inception date of a fund.
Source: Morningstar
Now, let’s explore the top 4 Natural Resource ETFs a little deeper. In the following chart I have selected FXZ, PYZ, RTM and VAW to compare in one handy chart.
FXZ vs PYZ vs RTM vs VAW: June 2007 – April 2018
Source: https://www.portfoliovisualizer.com/
Worthy of note in this chart is the fact that FXZ & PYZ are in a statistical dead heat (± 0.50% CAGR) in long-term performance. Also noteworthy is the outperformance of the more specialize funds (FXZ, PYZ & RTM) versus a more traditional sector fund such as VAW or XLB. This seems to be a sector where smart-beta funds can prevail long-term. If you are going to invest in this sector, it may be worth considering paying a higher expense ratio to potentially achieve a little more alpha in your investment. Each investor should consider all parameters such as investment time-horizon, expense ratios and commissions prior to investing in any sector fund.
To get a better understanding of how these top performing Natural Resources ETFs operate, let’s look at their stated fund objectives, strategies and product details from the associated fund family’s websites.
FXZ: The First Trust Materials AlphaDEX® Fund is an exchange-traded fund. The investment objective of the Fund is to seek investment results that correspond generally to the price and yield, before fees and expenses, of an equity index called the StrataQuant® Materials Index. The StrataQuant® Materials Index is an “enhanced” index developed, maintained and sponsored by ICE Data Indices, LLC or its affiliates (“IDI”) which employs the AlphaDEX® stock selection methodology to select stocks from the Russell 1000® Index. IDI constructs the StrataQuant® Materials Index by ranking the stocks which are members of the Russell 1000® Index on growth factors including three, six and 12-month price appreciation, sales to price and one-year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets. Stocks which Russell has classified solely as growth or value, receive their score using the above growth or value factors respectively. Stocks which Russell allocates between both growth and value receive their best score between the growth and value factors. IDI then ranks those stocks contained in the materials sector according to their score. The bottom 25% is eliminated and the top 75% is selected for the StrataQuant® Materials Index. The selected stocks are divided into quintiles based on their rankings and the top ranked quintiles receive a higher weight within the index. The stocks are equally-weighted within each quintile. The index is reconstituted and rebalanced quarterly.
PYZ: The PowerShares DWA Basic Materials Momentum Portfolio (Fund) is based on the Dorsey Wright® Basic Materials Technical Leaders Index (DWA Basic Materials Technical Leaders Index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to identify companies that are showing relative strength (momentum) and is composed of at least 30 common stocks from the NASDAQ US Benchmark Index. Relative strength is the measurement of a security’s performance in a given universe over time as compared to the performance of all other securities in that universe. The Fund and the Index are rebalanced and reconstituted quarterly.
RTM: The PowerShares S&P 500® Equal Weight Materials Portfolio (Fund) is based on the S&P 500® Equal Weight Materials Index (Index). The Fund will invest at least 90% of its total assets in common stocks that comprise the Index. The Index equally weights stocks in the materials sector of the S&P 500® Index. The Fund and the Index are rebalanced quarterly.
VAW: Seeks to track the performance of a benchmark index that measures the investment return of stocks in the materials sector. Passively managed, using a full-replication strategy when possible and a sampling strategy if regulatory constraints dictate. Includes stocks of companies that extract or process raw materials.
Now that we know how these Natural Resources ETFs are managed, let’s look at the performance of each fund vs the S&P 500 since their inception dates.
FXZ vs S&P 500: June 2007 – April 2018
Source: https://www.portfoliovisualizer.com/
PYZ vs S&P 500: November 2006 – April 2018
Source: https://www.portfoliovisualizer.com/
RTM vs S&P 500: December 2006 – April 2018
Source: https://www.portfoliovisualizer.com/
VAW vs S&P 500: February 2004 – April 2018
In conclusion, I would like to reiterate that I believe the Natural Resources sector is potentially a valuable asset to hold in a long-term investor’s portfolio. While I personally have selected FXZ to invest in, I believe long-term investors can do well investing in this sector with any one of the top 5 ETFs listed. (FXZ, PYZ, RTM, VAW or XLB).
Thank you for taking time to read this article. If you found it useful, please share it with a friend.
Respectfully yours, Micah McDonald, aka the Deep Value ETF Accumulator
Disclosure: I currently do not own any funds mentioned in this article. I do intend to invest in FXZ in the future. My brokerage house, TD Ameritrade, provides commission-free trading of FXZ. I am not a Registered Investment Advisor. Prior to investing in any fund mentioned in this article, please perform your own due diligence or seek the advice of a profession advisor.