The retail industry has undergone rapid changes in the last two decades, transforming from a collection of brick and mortar storefronts to a confusing mix of online and physical operations. The industry’s metamorphosis continues, with Amazon (AMZN) and other online portals taking steady market share from shopping malls and well-established old line companies. (See: The 4 R's of Investing In Retail).

E-commerce's annual growth rate will rise to 11% by 2016, according to a Nielson study, suggesting many physical retailers will have trouble surviving in the next 5 to 10 years. (For another point of view, see: 3 Reasons Costco Shouldn't Fear Amazon). Many traditional operations are addressing this challenge by establishing their own virtual shopping platforms, with mixed results. Wal-Mart (WMT) has been the clear winner in this competition for visitors, and now runs the fourth largest e-commerce website in the world.

Traders and investors have surprisingly few choices to capitalize on these dramatic industry changes, with just three non-leveraged sector exchange traded funds (ETFs): SPDR S&P Retail ETF (XRT), Market Vectors Retail ETF (RTH) and Invesco Powershares Dynamic Retail ETF (PMR). Consumer discretionary funds pick up the slack with many liquid opportunities but non-retail components in leisure, entertainment and telecommunications dilute sector purity. (For related reading, see: Are Derivatives Safe For Retail Investors?

Breaking Down Retail ETFs

SPDR S&P Retail ETF (XRT) tracks the retail sub-industry segment of the S&P Total Market Index, a modified equal weight index. This construction lowers the impact of the sector’s biggest names, offering more reliable tracking to broad industry catalysts. The fund held 102 stocks as of 17 April 2015, with most entries comprising around 1% of the total.

This is the purest play for general retail exposure, with more than 2 million average daily shares. Equal weighting is the fund’s biggest drawback because it’s harder to profit from conflicting industry developments, like the exodus to e-commerce portals. It’s easily shorted when bearish on the sector but currently pays a 3.80% yield, which becomes your liability when holding a short sale into the ex-dividend date.

Market Vectors Retail ETF (RTH) tracks Market Vectors U.S. Listed Retail 25 Index, a modified market cap weighted index that requires blue chip capitalization, 3 month average daily volume of at least 1 million shares and at least 250,000 shares traded per month over the last 6 months. Amazon and Wal-Mart currently comprise nearly 20% of the total fund weighting, equal to the combined weighting of the smallest 10 retailers in the index.

The fund’s popularity has plummeted since 2009 when it attracted nearly 2 million average daily shares and now trades just 103,000 average shares. SPDR S&P Retail ETF and broad consumer discretionary funds have captured the lost volume but the fund still trades with decent liquidity and a relatively tight spread. It’s also the go-to play when the industry’s highest capitalized components are moving the sector. 

Invesco Powershares Dynamic Retail ETF (PMR) has never caught on with market players and is currently trading just 28,000 shares average daily volume. It tracks the Dynamic Retail Intellidex Index, which is comprised of 30 components handpicked for price and earnings momentum as well as management action and overall perceived value.

This is an actively traded fund, with components reconstituted quarterly. Given its aggressive management, investors and traders may believe it will book stronger returns than more passive instruments but that hasn’t been the case. Since 2009, the fund’s 237% return has matched Market Vectors Retail ETF while S&P Retail ETF has grossly outperformed, rising 670% as of April 2015.

Market players looking for leveraged retail exposure have just one choice, Direxion Daily Retail Bull 3X Shares (RETL). This thinly traded fund, with just 14,000 average daily shares, tracks 3 times the Russell 1000 Retail Index. A bid-ask spread as high as $1.50 exceeds the risk controls of many trading and investment accounts, raising costs and lowering profitability. In addition, its daily reset undermines short-term returns, suggesting there are cheaper ways to play the sector. (For related reading, see: How The Retail Investor Profits From High Frequency Trading).

Bottom Line

Retail ETFs offer limited trading and investment choices, with two primary funds and a single illiquid leveraged fund. The consumer discretionary funds offer additional choices but non-retail exposure dilutes pure sector plays.

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