An ETF That Might Not Fly

Here we go again. The exchange-traded fund (ETF) industry has just introduced another new ETF focused on a narrow niche. ETFs were once known for largely tracking the big indexes, such as the S&P 500, and doing so with some advantages over mutual funds, too. (ETFs combine features of individual stocks and index funds. Read all about them in our ETF Center.)

So, what's the niche this time? Well, it's the airline industry, of all things. I say that because investors are presumably out to make money, and the airline industry has long been an effective destroyer of value. None other than Warren Buffett has disparaged it, noting in his 2007 letter to shareholders that, "Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."

Why is the industry so problematic? Lots of reasons. For one thing, remember how the price of gas went up a little a year or two ago? Well, that happens a lot, and it always puts pressure on the transportation industry. Airplanes consume a lot of fuel, even if a plane is mostly empty. Then there are fare wars, and complicated routing logistics, and the cost of those empty seats, and the cost of buying and maintaining expensive equipment, and so on.

Such considerations had me scratching my head at the new ETF offering and asking, "Why?" Just look at some of the holdings of the Claymore/NYSE Arca Airline ETF (which sports the clever ticker symbol FAA):

  • UAL Corp. (Nasdaq: UAUA  )
  • Southwest Airlines (NYSE: LUV  )
  • US Airways (NYSE: LCC  )
  • Delta Air Lines (NYSE: DAL  )
  • Continental Airlines (NYSE: CAL  )

Dear God, why?
None of those companies has been doing very well anytime in the recent past. So why this ETF? Who would invest in it? Here are some of my concerns:

  • There are so many other more profitable industries.
  • Investors might do a lot better investing in companies that serve the airline industry instead of the industry itself. For example, Boeing (NYSE: BA  ) and Embraer (NYSE: ERJ  ) both make airplanes and sport three- and five-star ratings (out of five) from our Motley Fool CAPS community, respectively. With the notable exception of Southwest Airlines, most of the rest that have been rated sport just a single sorry star.
  • Investors might also do better by just investing in Southwest (three CAPS stars), as it has a long track record of profits, unlike most other airlines. Yes, diversification is good, but this ETF is not diversified across different industries. When I checked, Southwest made up 11% of the assets of the fund, and Continental (one CAPS star) made up more than 12%. As an investor, that doesn't look promising.

Here's why
Of course, most questions have answers, and here are some. While one of the best ways to invest in ETFs is to choose broad-market index-based ones and hold on for many years, if you really want to focus on a whole industry, ETFs such as this one will let you do so. Instead of having to buy lots of individual shares in 10 or 25 companies, buying a single share (or more) of this ETF will instantly park you in a host of airlines. Simple.

Perhaps better still, you can also bet against the industry via an ETF. If you think the airline industry's shares, on average, are headed south, you can short the airline ETF in one fell swoop.

We believe in long-term investing in Fooldom, but if you really believe that airline stocks are headed up or down in the coming months or year, you might go long or short this ETF on a short-term basis.

So, the fund's existence isn't entirely insane. But if you approach it, do so carefully.

For some recommendations of funds that may give you significant outperformance, give our Motley Fool Champion Funds newsletter a whirl. It's free for 30 days with our trial subscription offer.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Embraer is a Motley Fool Stock Advisor recommendation. Try our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


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