XLK Technology Select Sector

The telecommunications industry is recognized as a major contributor to a global economic recovery thanks to a booming wireless business and its solid outlook. The smartphone market, the hot segment in the wireless zone, actually still has growth potential, and could remain a driver going forward.
 
This specialized segment of the telecom sector started gaining momentum in recent years and represents one of the few growth opportunities left for developed market investors (read: A Comprehensive Guide to Telecom ETFs).
 
As per market researcher Gartner, in the second quarter of 2013, smartphone sales exceeded feature phone sales for the first time and accounted for 51.8% of the overall mobile phone sales.
 
Shipments too were at a record high. The performance in the third quarter was even better than the preceding quarter in terms of shipments, affirming a continued winning momentum of the smartphone market.
 
The rising middle-income population especially in the emerging markets and lower pricing thanks to the low-cost Android solutions made this bull-run possible. Statistics also bear out the bullish trend.
 
Research agency IDC expects worldwide smartphone shipments to exceed one billion units in 2013, up 40% year over year. This would mark the first year to record such a huge volume.
 
In fact, strong global demand for smartphones aided the worldwide mobile phone market which is now expected to finish 2013 with 7.3% year-over-year growth, jumping from just 1.2% growth in 2012.
 
IDC now expects total smartphone shipments to reach 1.7 billion units in 2017 and lead the overall mobile phone market in the developed economies. Given this bullish trend, a look at some of the top ranked ETFs in the space could be a good way to target the best of the segment.

One way to find a top ranked ETF in the communication equities space is by using the Zacks ETF Ranking system (read: Zacks ETF Rank Guide).

 About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETFs in the context of our outlook for the underlying industry, sector, style box or asset class (see all the Zacks ETF Categories here).

Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium, or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the communication equities space, we have taken a closer look at the top ranked FONE. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below:
 
About FONE
 
Launched in February 2011, First Trust NASDAQ CEA Smartphone Index Fund (FONE) is a passively managed ETF that looks to track the performance of the Nasdaq OMX CEA Smartphone Index.

The product is well diversified from an individual security perspective, with Nokia accounting for 5.05% and taking the top spot. Compal Communications (3.51%), Samsung (2.97%) and Inventec (2.89%) hold the next three positions in the basket.

The fund is a nice mix of growth and value investing. FONE picked up stocks from various regions of the world with the U.S. accounting for about 40% followed by Taiwan (14%). As far as market capitalization is concerned, large caps lead the way with more than 55% of exposure.
 
A well-diversified coverage in terms of stocks, market capitalization and style of investing clearly explains why FONE can be a wise bet in a global slowdown.
 
This choice is an expensive one in the communication ETF space with 70 bps of annual fees, which is on the higher end of the average expense ratio of the space. The fund is also not quite liquid with a daily trading volume of around 3,000 shares per day (see more in the Zacks ETF Center).

The choice is an unpopular one with just $9.8 million in AUM. Holding 63 stocks in its basket, the product puts 30.4% of its total assets in the top 10 holdings, suggesting moderate concentration risk. 

As such, we have a ‘High’ risk outlook for FONE in the near term. The stocks under this segment are vulnerable to fierce competition and continuous changes in technology thus calling for some associated business risks.

Higher risk has resulted in higher return as well. The fund returned a robust 29.4% on a year-to-date basis as of October 30, 2013 and about 39.5% in the last one year.

The product also pays an annual dividend yield of 1.06%. FONE hit a low of $22.42 and a high of $33.50 over the last one year. The fund is currently hovering around its 52-week high price and may break that level in the coming year.

Bottom Line

Given the inherent potential of the smartphone industry, we could see additional gains in the months ahead (read: Robotics ETF on the Horizon?). So, for risk-tolerant investors seeking a new play on the communication space, this somewhat unnoticed smartphone ETF could be an interesting choice.

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FT-CEA SMRTPHN (FONE): ETF Research Reports
 
NOKIA CP-ADR A (NOK): Free Stock Analysis Report
 
SPDR-TECH SELS (XLK): ETF Research Reports
 
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Zacks Investment Research
 
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