Defensive Sector ETFs for the Fiscal Cliff - ETF News And Commentary

By Zacks | December 14, 2012 AAA

With the Fiscal Cliff just a few days away, investors are becoming all the more cautious as the risks are high for the U.S. economy to slip into another recession. The recent sell-offs in the market and the volatile moves are further evidence that market participants are growing worried over the impact of the economy diving over the cliff as we head into 2013 (Biotech ETFs: A Fiscal Cliff Safe Haven?). In such a scenario, the defensive sectors generally act as a safe haven and can be a great option for investors who desire to play safe. When it comes to investing in defensive sectors utility and consumer staples come first to mind.

Utility and consumer staples play their defensive role when the market turns south. This is because the products like power and water are the basic necessities that have relatively stable demand. Energy and water will possibly see a steady demand regardless of the circumstances in the market and hence could provide a shield from shocks in the marketplace (So Much for Safety: Utility ETFs in Bear Territory).

Similarly the consumer staples sector appears to be defensive as it includes manufacturers and distributors of food, beverages and tobacco and producers of non-durable household goods and personal products.

Also included are food & drug retailing companies as well as hypermarkets and consumer supercenters which are considered essential for daily needs. These products see a steady demand even during an economic downturn due to their low level of correlation with economic cycles (3 Consumer Staples ETFs for the Shaky Market).

Investors should note that the utility sector is also popular for its high yield which it provides to its investor. If we get over the fiscal cliff tax on dividends would be charged close to 45% which is much higher than the current 15% level. So, despite the defensive nature of the sector, it seems to be less attractive for investment.

However, the consumer staples sector does not offer such high yields on average. Investors therefore need not worry about the high dividend tax rate. They can thus shift their assets to this sector.

Investors seeking for safe havens if the fiscal cliff takes place can look to invest in this defensive sector that looks to be less impacted by the Cliff (3 ETFs to Prepare for the Fiscal Cliff). But instead of investing in single stocks, investors can put in their money in a portfolio of stocks in order to avoid the volatility of individual stocks.

ETFs are a great way to gain exposure to defensive sectors. We have briefly described below a handful of ETFs that provide access to stocks in the consumer staples space for those looking for a lower risk choice in today's uncertain environment:

Consumer Staples Select Sector SPDR Fund (XLP)

The Consumer Staples Select Sector SPDR Fund is the oldest product in the space with a high liquidity level which provides exposure to the consumer sector at the lowest cost. The ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the S&P Consumer Staples Select Sector Index.

The product appears to be liquid as more than six million shares change hands on a daily basis. The fund invests its $6,483.7 million assets in a small basket of 44 stocks.

The fund appears to be quite concentrated in the top 10 holdings as 66.5% of the asset base goes towards it. In fact, the top three holdings have a share of 34.65% in the fund.

Within the sector, the fund has double-digit allocation with a minimum allocation to personal products. Food & staples retailing gets the first preference in sector allocation. For this exposure, the investor pays an expense ratio of 18 basis points, one of the lowest in the space (Top Three Consumer Staples ETFs).

Vanguard Consumer Staples ETF (VDC)

Investors seeking to play a low risk space at a cheap price should invest in Vanguard Consumer Staples ETF (Four Vanguard ETFs for Long-Term Investors). The fund provides exposure to stocks of companies that provide direct-to-consumer products based on consumer spending habits and are considered non-discretionary.

The ETF tracks the MSCI US Investable Market Consumer Staples 25/50 Index and tracks a broader basket of 109 consumer staples stocks. The fund has a total asset base of $1.2 billion, of which 62.5% is invested in the top 10 holdings. So like XLP, this fund also appears to be concentrated with assets tilted towards the large caps.

Among the different industries, household products and soft drinks take the top spots with 36.9% of investment made in these two categories. VDC charges a reasonable premium of 19 basis points per year for the investment.

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