Comprehensive Guide to Telecom ETFs - ETF News And Commentary

By Zacks | September 19, 2012 AAA

Despite the lingering economic woes, the global telecom industry has nicely held up this year thanks to healthy growth and its traditional role as a safe haven. Still, the U.S. dominates the global growth picture in this space, as firms in this segment, thanks to new technology and intense consumer demand, have been able to sell a decent level of products to customers despite the sluggish economy (read: U.S. Telecom ETFs: Opportunities and Threats).

Wireless: A Key to Strong Growth

Currently, the wireless market is ready for the ongoing boom in the data space on the back of unprecedented growth of high-speed mobile Internet traffic and the emergence of mobile broadband technology. These capabilities have created a huge opportunity in a number of new areas such as IPTV offerings, cloud computing, video conferencing, online video streaming, mobile payments, managed telepresence and Long Term Evolution (LTE) technology based 4G networks (read: Inside The Cloud Computing ETF (SKYY)).

The LTE deployments will allow the global carriers to deliver the strongest and the most advanced networks. Additionally, the wireless operators are taking significant steps to alleviate competition from cable operators. As the smartphone market is growing rapidly and the wireless market has saturated, companies are progressing fast to acquire more spectrum in order to support their video content and other data services.

However, the industry is facing acute wireless spectrum crunch (read: Are Telecom ETFs In Trouble?). The operators are investing heavily for effective utilization of the existing spectrum holdings and are trying hard to add more spectrums to their portfolio. The rest of the investments go towards technological updates, entering new markets and enhancing capacity in the existing markets that have poor standards of service quality.

Consequently, the telecom sector is exposed to high debt levels and limited liquidity, which puts a premium on sustainable cash flow to service debt obligations. Despite these significant investments, demand is expected to outstrip supply in the short term, which could lead to suspended connections, rising prices and a decline in service quality.

Since the new spectrum auction by the FCC will not be available before the new decade, carriers are looking for smart technology solutions like "small cells" to avoid network congestion. The small cells are nothing but the mini versions of the gigantic wireless broadcast towers that send and receive networks for all cell phone calls. The revolution of these cells will be a big boon to the entire wireless industry, stimulating strong growth prospects in the years ahead.

Further, the growing popularity of Android smartphones, iPhones and tablet computers are boosting market share and would continue to do so in the future. The launch of much awaited Apple iPhone 5 would contribute additional interest in the telecom sector heading into 2013. 

How to Play the Telecom Sector?

For investors seeking to play the telecom market, an ETF approach form is arguably the best way that provides strong returns with minimum risk thanks to diversification and tax efficiency.

There are currently nine ETFs in the telecom space, which includes one leveraged ETF and one inverse ETF (see more in the Zacks ETF Center). These ETFs are different from each other in many aspects and we have highlighted some of the key aspects of each below:

iShares Dow Jones US Telecom ETF (IYZ)

Investors looking for exposure to both wireless and wireline telecom services could find IYZ an intriguing option. Launched in May 2000, the fund has attracted more than $600 million in assets, and as such, it is the largest and most liquid ETF in the space.

The fund tracks the Dow Jones U.S. Select Telecommunications Index, a subset of the Dow Jones Wilshire 2500 index, and holds 28 securities in its portfolio. If we look at individual holdings, IYZ does not widely spread out across securities and is instead heavily concentrated (read: Build a Complete Portfolio with These Three ETFs).

It allocates nearly 72% of the assets in the top 10 firms, with a 16.3% share in AT&T Inc. (T) alone followed by a 12.4% share in Verizon Communications Inc. (VZ). This suggests that company-specific risk is high in the case of IYZ and the top 10 holdings dominate the returns of the fund.

Further, the product is heavily weighted towards fixed-line telecom service providers with two-thirds of the share in the basket while mobile service providers take the remaining share. The fund has a slight tilt towards large cap securities, which tend to be more stable and less volatile than the mid and small counterparts, and target value stocks (read: Try Value Investing With These Large Cap ETFs).

The product is quite expensive with an expense ratio of 0.47% and tracking error is also relatively higher than the other funds in the space. The ETF is highly traded with volumes of more than 400,000 shares per day on average, suggesting a relatively narrow bid/ask spread.

It has delivered outstanding returns of nearly 20% to investors so far in the year (as of September 11) and pays an impressive dividend yield of 2.23% annually. Such returns are much more than the total expenses, making the fund an attractive play at present. 

iShares S&P Global Telecommunications Sector Index Fund (IXP)

This fund, launched in November 2011, provides global exposure to diversified and wireless service provider securities. It is the second largest fund in the space with assets of $585 million under management. The product seeks to match the price and yield of the S&P Global 1200 Telecommunication Sector Index, holding 38 securities in the basket.

Like many other funds in the space, the returns of IXP are explained by the returns of the top 10 holdings, which account for 69% of the assets. AT&T, Vodafone Plc (VOD) and Verizon take the top three positions with a combined share of nearly 41%. About 68% of the companies in the fund provide diversified telecom services and the rest offer wireless services.

The fund is skewed towards large cap and value stocks from across the globe with U.S. (comprising 35% share), UK (14%), Japan (8%), Canada (6%), Mexico (5%), Spain (5%), China (4%), France (4%), Australia (4%) and Germany (3%) getting a share of the pie.

The product returned about 12% year-to-date (as of September 11) and an attractive 4.80% in annual dividend yield (read: Three Excellent Dividend ETFs for Safety and Income). Trading in good volumes, the fund has a relatively low bid/ask spread that could lessen the cost slightly for this fund. The fund charges 48 bps in fees per year from investors.

Vanguard Telecom ETF (VOX)

This fund targets the telephone, data-transmission, cellular or wireless telecommunication services market. It seeks to replicate the price and performance of the MSCI US Investable Market Telecommunication Services 25/50 Index. The fund was initiated in September 2004.

With holdings of 35 stocks and AUM of $530.8 million, the product allocates the majority of its assets (nearly 71%) to the top 10 firms. AT&T, Verizon and Sprint Nextel (S) take the top spots in the basket and make up for a combined 50% share.

From a sector look, integrated telecom services holds the top position followed by wireless telecom services and alternative carriers. Large cap firms account for 58% of the assets while mid and small caps take the remaining portion of the basket.

The ETF is the low cost choice in the telecom space with an expense ratio of 0.19%, small bid-ask spread and good tracking error. Further, the fund generated excellent returns of 17% year-to-date (as of September 11) with a solid dividend yield of 2.76%.

In the end, high returns and low cost make VOX an interesting option to play the telecom market, which is considered the bright spot in the current world market (read: Four Vanguard ETFs for Long-Term Investors).

SPDR S&P International Telecommunications Sector ETF (IST)

Investors seeking an international exposure to the telecom market could choose State Street's IST. The fund tracks the S&P Developed Ex-U.S. BMI Telecommunication Services Sector Index, before fees and expenses. With a holding of 50 stocks, the fund has total assets of $24.2 million. It was initiated in July 2008.

In terms of holdings, the fund puts about 63% of total assets in the top 10 firms with the largest allocation going to Vodafone (19%). It generally consists of large cap securities with a tiny portion apportioned to mid and small caps. Like ISP, the product is widely spread across a number of countries. European companies dominate the fund portfolio followed by those based in the Asia-Pacific region, North America, and Asia (read: Three European ETFs That Have Held Their Ground).    

The fund is less liquid as it trades in volumes of about 10,000 shares per day. This nature increases the cost of trading in the form of relatively wide bid/ask spread beyond the expense ratio of 0.50%. The product returned only 7% in the year (as of September 11) and yields higher an annual dividend of 6.02%.

SPDR S&P Telecom ETF (XTL)

Launched in January 2011, the fund seeks to match the performance of the S&P Telecom Select Industry Index. It holds 53 securities in the basket with a large focus on small caps.

The fund is widely diversified across individual securities, as it has minimal concentration in the top 10 firms. None of the securities in the fund's portfolio has more than 3.5% of the share (read: Three ETFs With Incredible Diversification). 

Sprint, MetroPCS (PCS) and Aruba Networks take the top positions in the basket with less than a combined 10% of assets. The product has a nice mix of sector allocations: communication equipment (56.7%), wireless services (21.0%), integrated services (13.8%), alternative carriers (6.3%) and application software (2.2%).

The fund has so far attracted assets of $4.5 million this year. Though the fund charges 35 bps in annual fees from investors, it has a wide bid/ask spread thanks to small trading volume. The product has gained 8% this year (as of September 11) and yields only 0.77% in dividends per annum.

EGShares Telecom GEMS ETF (TGEM)

Investors looking to play the emerging market in the telecom space can find TGEM an exciting pick. The fund is not too old in the space, making its debut in June 2011. It tracks the Dow Jones Emerging Markets Telecommunications Titans 30 Index, holding 30 securities in the basket.

With AUM of $4.1 million, the product puts nearly 54% of assets in the top 10 holdings. China Mobile and America Movil (AMX) take the top two positions in the fund's portfolio with a combined share of 20%. The securities in the fund are considered to be large cap stocks, divided between mobile (72.4%) and fixed line (27.4%) telecom sectors.

South African and Brazilian companies dominate the fund's portfolio with 10% of the assets. Mexican, Russian, Thai, Turks, Indian and Indonesian companies constitute less than 10% of the assets (read: Forget Brazil; Mexico ETF is Hot).

The fund is expensive, charging annual fees of 85 bps from investors. Additionally, the product has a wide bid/ask spread due to the paltry trading volume of just 2,000 shares per day. Despite the high cost choice, the fund produced impressive returns of more than 12% so far in the year (as of September 11) and yields 1.03% in annual dividends.

MSCI ACWI ex US Telecommunication Services Sector Index Fund (AXTE)

This fund targets the developed and emerging markets of the telecom sector, excluding the U.S. Launched in July 2010, the fund seeks to replicate the performance of the MSCI All Country World ex USA Telecommunication Services Index. The ETF has total assets of $2.7 million under its management and holds 68 securities with a heavy focus on the top 10 firms.

The top company Vodafone alone makes up for a 16% share in the basket while China Mobile and Telefonica (TEF) combined make up 14% of the share. The product consists mostly of large cap securities with an equal distribution between diversified services and wireless services companies.

From a geographic perspective, the fund allocates a large part to European companies followed by Asia Pacific, Asia, Latin America, North America, Africa and the Middle East (read: Developed Asia Pacific ETF Investing 101).

Though the fund charges 48 bps in fees per year from investors, its illiquid nature increases the cost of investing, in the form of a wide bid/ask spread. AXTE has delivered the least return in the telecom space, gaining nearly 6% year-to-date (as of September 11). The fund pays attractive dividends with a yield of 5.38% per annum.

Ultra Telecommunications ProShares ETF (LTL)

Launched in March 2008, the fund seeks to deliver twice (200%) the daily performance of the Dow Jones U.S. Select Telecommunications Index. The fund manages $4.5 million of assets and holds 29 securities in the basket, allocating about 72% share to the top 10 firms. AT&T, Verizon and Sprint take the top spots in the basket with a combined 37% share of the assets.

From a sector perspective, the product is tilted toward the fixed line telecom sector with a 69% share and the rest is taken by mobile telecom. Large caps account for 51% of the assets while mid and small caps take the remaining portion of the basket. The ETF is the high cost choice in the space due to its illiquid nature and the leverage approach (read: Understanding Leveraged ETFs). It trades in a paltry volume of just 600 shares per day.

This is suitable for the risk tolerance investor seeking abnormal returns. The fund generated whopping returns of more than 41% so far this year (as of September 2012) but yields annual dividends of just 0.28%.

UltraShort Telecommunications ProShares ETF (TLL)

Like LTL, the fund tracks the Dow Jones U.S. Select Telecommunications Index but provides inverse exposure to two times (200%) the daily performance of the index. The fund has total assets of $1.7 million and charges 0.95% in annual fees from investors.

Beyond the expense ratio, investors have to pay additional cost in the form of a wide bid/ask spread due to scanty trading volume. The ETF is suitable for risk tolerance investors thinking differently from those who want to go long in the space. Still, it has lost around 34% value year-to-date (as of September 2011) but yields dividends of 2.64% per annum (read: Three Unlucky Equity ETFs).

Provided below is the summary of the ETFs discussed above for those seeking a side-by-side comparison:

Fund Name

Inception Date

Issuer

AUM (in millions)

No. of Holdings

% of Assets In Top 10 Holdings

Expense Ratio

Distribution Yield

YTD Return (as of Sep. 11, 2012)

IYZ

May-00

iShares

$609.3

28

71.87%

0.47%

2.23%

19.60%

IXP

Nov-11

iShares

$585.0

38

68.61%

0.48%

4.80%

11.75%

VOX

Sep-04

Vanguard

$530.8

35

71.20%

0.19%

2.76%

17.23%

IST

Jul-08

State Street

$24.2

50

62.75%

0.50%

6.02%

7.20%

XTL

Jan-11

State Street

$4.5

53

28.18%

0.35%

0.77%

7.88%

TGEM

Jun-11

EGShares

$4.1

30

53.77%

0.85%

1.03%

12.39%

AXTE

Jul-10

iShares

$2.7

68

55.65%

0.48%

5.38%

5.55%

LTL

Mar-08

ProShares

$4.5

29

71.94%

0.95%

0.28%

41.13%

TLL

Mar-08

ProShares

$1.7

29

71.94%

0.95%

2.64%

   -33.69%

 
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