iShares U.S. Industrials ETF (BATS:IYJ) is another sector based BlackRock ETF as the name implies. The fund tries to invest in a basket of American companies that are considered industrial. In this article we will talk about pros and cons of this fund and why I consider it a Hold for the most part.
There is a lot of confusion about this term because the word has had at least two meanings based on historical context. One of those meanings refers to any branch of economic activity such as healthcare industry, tourism industry and finance industry. The other meaning of the word specifically refers to the manufacturing sector. For example when Dow Jones Industrial Index (DJI) was first developed, it only included companies engaged in manufacturing of goods or producing materials such as American Can, American Smelting, Chrysler, General Motors and US Steel.
This fund seems to combine the two meanings of the word industry or industrial. It includes a large number of companies that manufacture things such as Caterpillar (CAT), Boeing (BA) and Deere (DE) but you might be also surprised to find that the fund’s top holdings include stocks like Visa (V), Mastercard (MA) and Accenture (ACN) which account for a combined weight of 18% of the fund and these have little to do with manufacturing if you don’t count Accenture’s consulting services to the industry. Mind you Visa is also part of the Dow Jones Industrial Index which is one of the three main indices tracked by American investors as a benchmark.
Practically almost all of the fund’s holdings are headquartered in the US and again we see Accenture as an exception to this rule since the company is headquartered in Dublin, Ireland but this seems to be mostly for taxation purposes. When we look at the company’s holdings by sector, we see 22% of its weight going to Financial Services which is mostly Visa, Mastercard and PayPal while banks make only 0.31% of the total weight so the fund considers financial services as part of industrials but not banks. Interestingly enough semiconductors also make a very small percentage of the fund’s total weight even though it’s becoming one of the major industries in the US. Close to half of the fund’s total weight goes to Capital Goods which is basically manufacturing even though the name of the fund implies that this should have been a bigger part of the fund.
Even though companies in the fund are headquartered in the US, a great majority of them are global corporations that do business across the world such as Visa, Caterpillar and Boeing. In fact it would be very difficult to find a major industrial company that only does business in the US or only in a few countries maybe with the exception of the defense industry. Defense companies like Lockheed Martin (LMT) can only do business in countries where the US government approves them to do so but this particular sub sector is an exception rather than the rule.
In the last 10 years this fund resulted in total returns of 172% which falls slightly below that of the Dow Jones Index and falls slightly further behind the performance of the S&P 500 index (SPY). This makes me wonder if investors would be better off just holding a Dow Jones fund instead of this one especially considering Dow Jones index funds (DIA)( usually come with an expense ratio of 0.1% versus this fund’s expense ratio of 0.4%. This may not seem like a big difference but it can add up over many years.
The fund’s dividend yield also seems to be half of what investors could get from Dow Jones Index. This could be because of some of the fund’s top holdings which either have no dividends or very small yields but I still find it surprised that there is this much difference between this fund’s yield and Dow’s yield.
Another thing that surprised me is that the fund doesn’t seem to hold any car companies (as of the time of writing this article which could always change). I actually downloaded the Excel file on the fund’s page to make sure and went through every line and couldn’t find any mentions of any major car companies such as General Motors (GM), Ford (F) or Tesla (TSLA). Combined together, these three car companies generate $430 billion in annual revenues and employ more than 300k people not to mention all those people employed in dealerships, maintenance, supply chains and infrastructure. I’d consider automotive as one of the biggest industrial sectors in America which have an estimated impact of 8 million jobs in the country. Then again one could make the argument that Dow Jones Index doesn’t have any car manufacturers either even though the index used to include at least one car manufacturer for most of its history (General Motors was part of it from 1910s all the way to 2008). Maybe it’s time for Dow to add a car company to its mix again as well.
Industrials sector is one of those sectors that happen to be a major pillar of the American economy (as well as the global economy) and it’s a good idea to be invested in this particular sector but keep in mind that this is a capital intensive business. Manufacturing companies have to constantly invest in new factories, new production facilities, new tools, new ways of building goods, and there is a constant race for securing materials, parts and qualified employees. Many manufacturers have low margins and heavy debt. These companies tend to be highly cyclical and very sensitive to the state of the economy as well as interest rates. When interest rates rise and the economy slows down, they tend to suffer significantly because their fixed costs are too high and they can’t adjust their costs as quickly as let’s say a software company.
When a manufacturing company makes an investment by building a new factory or new supply chain, it can take many years before they recuperate their costs in this new investment. Also it’s very difficult for manufacturers to move from one country to another if there are reasons for them to move whether it be a political or economical need. When you are building big, complicated machinery, even missing one material or one part might disrupt production in a major way so these companies have to make sure that their supply chain is intact at all times or find alternative supply chains in case something goes wrong.
This is why industrial companies historically sold at a discount and carried lower multiples but we are not seeing this in this particular fund. The fund’s total P/E is 22 and price to book value is 4.7 which can be considered “pricey” for this particular sector. This is probably driven by high P/E ratios of some of the fund’s top holdings such as Accenture, Visa and Mastercard which trade for P/E ratios in 30s.
This fund isn’t bad per se but investors might be better off buying Dow Jones Index or S&P 500 index it they want a healthy level of exposure to the sector of industrials without giving up much upside. Index funds seem to be doing a better job of this than this particular fund when we look at long term performance differentials although not by a huge margin either.