Who Else Wants An Automotive ETF?

by on February 19, 2010 | ETFs Mentioned:

The ETF industry has expanded rapidly in recent years, with hundreds of new product launches covering various regions, sectors, and investment strategies. The surge in ETF product offerings–there are now nearly 1,000 exchange-traded products in our ETF screener–has sparked some speculation that the industry has reached a point of saturation–or perhaps has long since blown through that point.

There’s certainly some good support for such a notion. At the end of 2009, approximately 250 ETFs–more than a quarter of the industry–had less than $20 million in assets. The last three years have seen an ETF arms race, as issuers churned out niche products and assumed that investors would be chomping at the bit to get into anything that was first to market. There is little doubt that 2010 will see a wave of ETF closures (it’s started already) as issuers cut their losses on products for which demand never materialized. The “land grab” appears to be winding down, as issuers have begun responding to demand (rather than trying to create it) and success rates of new ETF products has surged.

For all of the alleged overdevelopment in the ETF industry, there still seem to be some rather obvious holes in the coverage blanket. The fixed income ETF space has significant room for expansion, and options for more targeted international exposure are growing rapidly. But there are some good ideas beyond these areas (see these two features outlining ETFs that don’t exist, but should).

FerrariMaybe I’m biased (I started my career as an analyst at a “big three” manufacturer in Detroit), but an automotive ETF seems like a slam dunk success. There are already ETFs focusing on airlines (FAA), gaming (BJK), and media companies (PBS). There are two covering the timber sector and at least three focused on water resources. With dozens of consumer products ETFs, it seems strange that no one has brought to market a fund focusing on the Ultimate American Consumer Product.

Sure, the auto industry is a dog whose glory days are behind it, but that doesn’t mean there’s no investment interest. Investors may not be clamoring to add auto exposure to retirement portfolios, but I’m guessing there would be more than a few interested in a car ETF as a short to intermediate term play, in both long and short positions. As the somewhat surprising turnover numbers indicate, ETFs aren’t just for buy-and-holders any more, and more volatile sectors have become popular with active traders. Moreover, Americans love their cars, and investors generally feel more confident investing in companies or sectors whose operations and products they understand clearly. Every car buff in the country would have a strong opinion on where this fund would be going.

Despite (or perhaps because of) less-than-impressive results in recent years and an uncertain outlook, the auto industry hasn’t fallen off of investors’ radar screens. Ford (F) trades nearly 200 million shares daily, with volumes surging when monthly sales data and other statistical bulletins are released. With the prospects of the entire car industry hinging on so many unique factors–everything from climate change initiatives to China demand to federal bailout money and stimulus plans–automotive stocks are generally among the most active and widely-traded securities out there.

The rise of the ETF industry shows a clear preference towards owning a sector over owning an individual stock or a handful of companies, a trend that would likely apply to automobiles as well as it has to the financials, tech, and energy industries.

Nuts And Bolts

In addition to the high level appeal, an automotive ETF seems to be very doable, as there are already a number of automotive-specific benchmarks. The MSCI U.S. Investable Market Automobiles & Components Index, for example, is a market capitalization-weighted index of stocks designed to measure the performance of Automobiles & Components companies in the MSCI U.S. Investable Market 2500 Index.

Fidelity already offers an actively-managed mutual fund benchmarked to this index, the Select Automotive Portfolio (FSAVX), and the holdings of this fund (shown here) are a good starting point for a hypothetical ETF. Ideally an ETF could be expanded to a global focus, thereby including companies like Toyota, Honda, Volkswagen, and Nissan, as well as carmakers in emerging markets like India’s Tata and China’s “big five” (Dongfeng, First Automobile Works, Shanghai Automotive Industry, Chang’an Motors, and Chery).

Splitting exposure between car manufacturers and companies engaged in the production of various components (like Johnson Controls, Borg Warner, Autoliv, Goodyear, and Tenneco) would provide exposure to all tiers of the automotive industry, and would significantly increase the number of potential constituents. Getting to 40 components, which would allow our hypothetical auto ETF to avoid giving a significant allocation to any one company, would be no problem.

Besides the fundamental appeal to investors looking to long or short the automotive sector, an ETF issuer out there could certainly come up with a clever ticker to market such a product. Some of the best options are already gone (CAR, MPG, and RPM are all taken), but there are a handful of other possibilities, like AUTO, HORN, MTWN, and CARS.

Already 2010 has seen a wave of new product launches, and ETF issuers are working on dozens more that could hit the market in coming months. Hopefully someone out there is hard at work on an automotive ETF.

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Disclosure: No positions at time of writing.