Aerospace and Defense ETFs Surge Amid Escalating Middle East Tensions
Aerospace and defense exchange-traded funds (ETFs) have emerged as strong performers this week, showcasing impressive gains even as broader U.S. stock markets have faced challenges due to rising geopolitical tensions in the Middle East. Analysts suggest that this particular sector is poised to outperform the S&P 500 in light of growing concerns regarding potential conflicts in the region.
Market Context and Analyst Insights
Ed Yardeni, president of Yardeni Research, underscored the significance of the escalating situation in the Middle East in a recent note dated October 1. He identified a widening conflict as the number one risk to the ongoing bull market in stocks. As he outlined, the probabilities he assigns to various economic scenarios are: a 50% chance of a robust economic environment reminiscent of the “Roaring 2020s,” 30% likelihood of a melt-up similar to the 1990s, and a 20% chance of geopolitical turmoil akin to the 1970s.
The recent missile attack on Israel by Iran has further heightened anxieties, prompting warnings from the White House regarding “severe consequences.” This development comes roughly one year after a deadly terror attack by Iran-backed Hamas on October 7, intensifying the already complex geopolitical landscape.
ETFs Performance: A Year in Review
Despite the wider market pullback, notable aerospace and defense ETFs have maintained substantial gains. For instance, the iShares U.S. Aerospace & Defense ETF (ITA), Invesco Aerospace & Defense ETF (PPA), and SPDR S&P Aerospace & Defense ETF (XAR) remained resilient amidst market fluctuations. According to Aniket Ullal, head of ETF research and analytics at CFRA Research, these three funds dominate the category based on assets under management.
Leading the way is the Invesco Aerospace & Defense ETF, with approximately $4 billion in assets under management (AUM). Year-to-date, the fund has surged by 24.9%, outpacing the S&P 500’s gains by more than five percentage points. Notably, over the past 12 months, it has skyrocketed by 46.6%, surpassing the SPDR S&P 500 ETF Trust (SPY) by nearly 12 percentage points.
The larger iShares U.S. Aerospace & Defense ETF has also performed admirably, with a 44.6% increase in the last year, while the SPDR S&P Aerospace & Defense ETF tracked a 43.5% gain. Smaller funds like the Global X Defense Tech ETF (SHLD) and the First Trust Indxx Aerospace & Defense ETF (MISL) have outshone larger counterparts, boasting increases of 58.7% and 48.2%, respectively.
Cost Considerations
When it comes to expenses, the SPDR S&P Aerospace & Defense ETF is the most cost-effective option among the top three ETFs, maintaining an expense ratio of 0.35%. This compares favorably to the iShares ETF’s expense ratio of 0.4% and Invesco’s 0.57%. Among the smaller ETFs, the Global X Defense Tech ETF has a 0.5% expense ratio, while First Trust’s fund is slightly higher at 0.6%.
Portfolio Composition and Sector Exposure
The differentiation in portfolio construction among these ETFs is significant, particularly in the concentration of their largest holdings. The SPDR S&P Aerospace & Defense ETF follows an equal-weighted index approach, while both Invesco and iShares ETFs utilize market-capitalization-weighted strategies.
The Invesco Aerospace & Defense ETF distinguishes itself with almost 6% allocated to the information technology sector, highlighting its focus on tech-driven aerospace solutions. Its leading stocks include Lockheed Martin Corp. (LMT), RTX Corp. (RTX), GE Aerospace (GE), and Boeing Co. (BA), each holding more than a 7% weight in the portfolio. Additionally, it has strategic investments in tech firms like Palantir Technologies Inc. (PLTR), which has seen remarkable growth of approximately 128.5% this year.
In contrast, the iShares U.S. Aerospace & Defense ETF is more top-heavy, with the majority of its top three holdings—GE Aerospace, RTX, and Lockheed Martin—occupying heavier weightings compared to those in the Invesco fund. The SPDR S&P Aerospace & Defense ETF, on the other hand, includes companies like Curtiss-Wright Corp. and L3Harris Technologies Inc. within its top five holdings, all maintaining a weight around 5%.
Investment Trends and Flow Dynamics
Interestingly, the inflow of capital into these ETFs provides an indication of investor sentiment. The Invesco Aerospace & Defense ETF has garnered nearly $1.4 billion in inflows over the past year, significantly outpacing the $263 million of inflows into the SPDR S&P Aerospace & Defense ETF. In stark contrast, the iShares U.S. Aerospace & Defense ETF experienced $653 million in outflows.
Despite strong performance across the sector, Ullal notes that while flows typically respond to market events, they do so at a slower pace than price movements. This could suggest that investors are still weighing the geopolitical risks in their decision-making processes, allowing for the opportunity for aerospace and defense ETFs to keep gaining ground.
In a rapidly changing global landscape, aerospace and defense ETFs may continue to attract investor interest as tensions in the Middle East evolve. With strong performance metrics backing them, these funds may prove pivotal for investors seeking stability amid uncertainty.