First Trust Debuts Smartphone ETF (FONE)

by on February 18, 2011 | ETFs Mentioned:

Score another first for the ETF industry; today marks the launch of the first ETF to offer pure play exposure to companies engaged in the smartphone segment. The First Trust NASDAQ CEA Smartphone Index Fund (FONE) is linked to a modified equal dollar weighted index that includes companies primarily involved in the building, design, and distribution of the handsets, hardware, software and mobile networks associated with the development, sale, and usage of smartphones. “First Trust is extremely pleased to launch another pioneering exchange-traded fund,” said Robert Carey, the company’s Chief Investment Officer. “We continually evaluate opportunities to broaden the First Trust family of ETFs, and FONE will enhance our unique specialty sector offerings.”

The new fund is global in nature, with U.S. companies accounting for about 45% of assets. Other big weightings are made to Taiwan (11%) and Japan (9%), while more than a dozen individual countries are represented in the ETF’s holdings. At the individual security level, FONE’s components includes some well known firms such as Motorola, Samsung, and LG Electronics as well as a number of companies with which most consumers likely aren’t familiar. Sub-sectors represented in the fund include semiconductors (25%), communications equipment (23%), and electronic equipment instruments and components (18%).

In order to be eligible for inclusion in the underlying index, securities must be identified as being engaged in the smartphone industry by the Consumer Electronics Association. They must also be listed on an index-eligible exchange as determined by NASDAQ OMX, have a market cap of $250 million, and have a minimum three month average daily trading volume of at least $1 million [see Ten ETFs To Be Excited For In 2011].

The securities in the NASDAQ OMX CEA Smartphone Index are allocated to one of three business segments: 1) handsets, 2) software applications and hardware components, and 3) network providers. The index is weighted 45% each towards handsets and software applications and hardware components, with the remaining 10% allocated to network providers. Index components are then equally weighted within each business segment, with semi-annual reconstitutions and quarterly rebalancing [see all the ETFs in the Communications Equities ETFdb Category].

Playing The Smartphone Boom

It’s no secret that adoption of smartphones has increased tremendously in recent years. Annual global sales of smartphone units have grown to nearly 250 million, and are expected to surpass PC sales by 2012. According to Bloomberg,worldwide smartphone sales are projected to more than triple to 491.9 million units by 2012 from 139.3 million in 2008. In the same period, worldwide PC sales are expected to expand to 443.1 million units from 290.8 million. Smartphones now account for about 30% of wireless device sales in the U.S., and that percentage is expected to climb to more than 40% in the next three years. For many devices, supply simply can’t keep up with surging demand. “We are working around-the-clock to build more,” said Apple COO Timothy Cook in a call with analysts following a recent earnings report. “I feel great that the demand is so high, but at this point, I’m not going to predict when supply and demand will meet. We believe the reaction and results from the Verizon customers will be huge, and so I don’t want to give a prediction right now when the supply and demand will crawl.”

As technological improvements and increased competition put downward pressure on prices, smartphones are becoming affordable for larger portions of the population in the U.S. and abroad. Not surprisingly, a major opportunity may exist in emerging markets, where penetration rates are considerably lower than in the developed world. Apple’s revenues from Greater China (including mainland China, Hong Kong, and Taiwan) was $2.6 billion last quarter, up more than 300% from the same period a year earlier. There’s obviously more to emerging markets than just China and more to the smartphone market than just the iPhone, but these figures help to illustrate the tremendous potential in the developing world.

According to London-based research firm Wireless Intelligence, four out of five new mobile phone subscribers are from developing countries. Of China Mobile’s 590 million subscribers only 90 million own smartphones, highlighting the relatively low penetration rates (and tremendous growth opportunities) in the world’s most populous country [see Three ETFs For Smart Phone Exposure].

On the surface, the idea of a smartphone ETF may seem as gimmicky as it gets. But the underlying index is constructed in a manner that offers balanced, efficient exposure to a compelling investment thesis; that smartphone adoption is on the rise–especially in emerging markets where penetration rates are a fraction of levels seen here in the U.S. FONE isn’t just Apple and Verizon with a 70 basis point expense ratio; it includes a number of smaller companies engaged in various corners of the industry that may not have the glitz of AAPL, but are nevertheless positioned to profit from a long-term shift in how we use technology [see ETFs With AAPL Exposure].

Test For ETFs

The launch of FONE will be an interesting test for the ETF industry. A few years ago a number of hyper-targeted funds debuted, but failed to garner significant assets and were quickly shuttered (the Metabolic-Endocrine Disorders ETF and the Wal-Mart Suppliers ETF were among the more creative products). Now that the ETF industry has grown tremendously and entered into the investing mainstream, it will be interesting to see just how interested investors are in the smartphone fund.

[For more info on the new smartphone ETF, see the FONE fact sheet. For news on all new ETF launches, sign up for our free ETF newsletter.]

Disclosure: No positions at time of writing.