Closer Look At The Texas ETF (TXF)

by on June 3, 2010 | ETFs Mentioned:

From a certain perspective, the ETF space shows the signs not of a still-nascent industry, but of a mature corner of the investing world. For the better part of a decade, the industry totem pole has remained unchanged, with four big firms accounting for nearly 90% of all ETF assets. But a closer look reveals that quite a bit has changed in recent years, as the number of players in the ETF game has grown significantly. None of these start-ups are a real threat to challenge the iShares and State Streets of the world, but many have experienced success in carving out a niche of more targeted products.

The number of exchange-traded products available to U.S. investors has climbed steadily towards 1,000, with the expansion occurring largely as the result of innovation, not duplication. Instead of a wave of identical S&P 500 ETFs (there are still only two), the growth has come from new ideas and more specialized products. Sector-specific emerging market funds, hedge fund replication strategies, and a physically-backed platinum ETF are just a few of the first-to-market products to emerge over the last two years.

Another innovation in the ETF world is state-specific funds rolled out by Geary Advisors last year, including the Oklahoma Exchange Traded Fund (OOK) and Texas Large Companies ETF (TXF). Earlier this year, we took a look at the reasons behind OOK’s hot start (see Why OOK Is Crushing XLE); now we take a closer look at the Texas ETF.

Under The Hood

TXF tracks the SPADE Texas Index, a modified market cap-weighted benchmark consisting of the largest publicly-traded companies headquartered in the state of Texas. So it’s not surprising that a number of the fund’s largest holdings are big oil companies; Schlumberger, ExxonMobil, ConocoPhillips, and Anadarko Petroleum are all among the largest allocations. In total, about 65% of TXF’s holdings fall into the energy sector, with the remainder spread across materials, technology, telecom, and others (see an “x-ray” look at TXF holdings). Among the best-known non-energy components are AT&T, Southwest, Whole Foods, Dell, and Texas Instruments.

So why an ETF focused solely on companies domiciled in Texas? TXF is, in a sense, similar to the ultra-popular QQQQ (which tracks the Nasdaq 100 Index) with the energy sector swapped in for tech companies. Both ETFs allocate about 65% of holdings to a primary sector, with the rest diversified across a number of different industries (see this Q&A With Keith Geary describing the rationale behind TXF). Over the last several years, this energy-heavy portfolio has performed pretty well compared to the broad market, beating the S&P 500 by a considerable margin according to a “blind back test.”

Texas tends to rank near the top in various lists of the best states in which to do business, thanks in part to the favorable “business tax climate”. The companies that are found in TXF obviously do business not only throughout the U.S., but throughout the world as well, so the local business climate won’t necessarily translate directly into higher earnings and better performance. But it’s worth noting that in an environment that has witnessed several cash-strapped states delay tax refunds and the likelihood of muni defaults skyrocket, Texas is on relatively solid financial footing.

Deepwater Drama

After surging to start the year, TXF has stumbled over the last month, as the fallout from the yet-to-be-resolved disaster in the Gulf of Mexico has weighed heavily on all oil-related stocks. Most investors are expecting Washington to come down hard on the companies at fault in the spill, anticipating that tougher legislation and restrictions on drilling activity may punish the entire industry for the mistakes of a few.

In late April, TXF had posted a year-to-date gain of nearly 10%. But the chaos of recent weeks has erased those gains and plunged the fund into the red; TXF is currently down about 7.4% on the year.

For investors looking for a cheap way to access the energy sector, TXF is an interesting option (it charges an expense ratio of just 0.20%, cheaper than XLE).

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Disclosure: No positions at time of writing.