RXI - VanEck Retail ETF: Exposure As Advertised But With An Asterisk

2023-10-03 06:48:39 ET

Summary

• The VanEck Retail ETF invests across 25 retail industry stocks.
• Amazon.com represents a significant portion of the fund's weighting, raising concerns about concentration.
• The fund has performed well historically, but we believe investors can do better going forward with more diversified ETFs.

The VanEck Retail ETF (RTH) provides targeted exposure to 25 of the most important retailers traded on U.S. stock exchanges. Companies in the industry share similar high-level macro trends between economic growth and consumer spending while leveraging new technology for a positive long-term outlook.

Impressively, RTH with a 236% cumulative return has outperformed the 206% gain in the S&P 500 Index ( SP500 ) over the last 10 years. Much of this spread reflects the momentum from retail leaders that have consolidated their market share, particularly through the rise of e-commerce.

That being said, a deeper look at the fund warrants some caution considering what we find to be a highly concentrated profile with a current portfolio position that leaves a lot to be desired. RTH performs as intended, but it comes with high risk and may not be what some investors are looking for.

What is the RTH ETF?

RTH technically tracks the "MVIS US Listed Retail 25 Index" which captures the performance of companies involved in the distribution and wholesale of consumer goods across specialty retailers, and e-commerce. This industry theme covers apparel, automotive, computer and electronics, drug, home improvement, and home furnishing retailers, as well as grocery chains.

Amazon.com, Inc. ( AMZN ) takes a prominent role in the fund representing 19.5% of the total weighting given the company controls upwards of nearly 40% of e-commerce in the United States. Its $1.3 trillion market value dwarfs other companies within the adjusted free-float market cap weighting methodology.

Big box retailers are also well represented in RTH with The Home Depot Inc. ( HD ), and Walmart Inc. ( WMT ) each with a 9% weighting. Down the list, we find some diversity in the group with McKesson Corp. ( MCK ) as a pharmacy wholesaler. O'Reilly Automotive Inc. ( ORLY ) and AutoZone Inc. ( AZO ) highlight the importance of retail auto parts. Kroger ( KR ) covers grocery stores.

We mentioned the concentrated portfolio. This is it with the top 10 holdings contributing to 72% of the total weighting. The setup has worked with RTH returning 6% this year, but we can point out that the bulk of that gain has come from the rally in AMZN this year through its 51% return. That dynamic is similar when we look back over the last several years.

While investors likely won't be complaining, the concern here is the company-specific risk from this single stock which would accelerate losses to the downside on a potential round of volatility.

Limitations of the RTH Strategy

Overall, RTH is what we'd expect to find in a "retail industry" ETF but we'd also say its particular structure or underlying index methodology has some faults and leaves a lot to be deserved. We can point to the following considerations that represent some of the weaknesses of the strategy, in our opinion.

First, the exposure to AMZN is quite high at 20% of RTH and nearly defeats the purpose of an ETF. We agree that Amazon is a great company and has significantly outperformed the market over the last decade, but we'd like to see some of that concentration better spread out.

Consider that more than half of Amazon's operating income in the last reported Q2 was based on its AWS cloud business segment which would be better classified as in the technology sector. By this measure, the company's actual relationship to "retail" could warrant a smaller weighting in the fund.

Second, we can question why some stocks are included but others miss the cut. Lululemon Athletica Inc. ( LULU ), for example, is an RTH holding but not Nike Inc. ( NKE ) which we believe is a global retail leader. Similarly, Costco Wholesale Corp. ( COST ) is included but not BJ's Wholesale Club Holdings Inc. ( BJ ). eBay Inc. ( EBAY ) is another name that is important to online retail, in our opinion. Notably, RTH lacks exposure to "luxury" apparel retail names which is disappointing.

Finally, we can bring up RTH's lack of international representation. It's curious that JD.com ( JD ), as a major Chinese e-commerce name, is the only foreign company included.

The point here is to say that industry classifications often blur the line into other segments of "consumer discretionary". It's difficult to draw the line between retail and other related cyclical industries. The limitation of RTH's 25 constituents may not be enough to capture the full breadth of the industry globally. We'd like to see a larger portfolio overall.

Alternatives To RTH

No ETF is perfect but we can point out some alternatives for investors to consider. Among large-cap U.S. companies, we believe the broader consumer discretionary sector ends up capturing the same essence of the "retail" industry.

In this case, the Consumer Discretionary Select Sector SPDR ETF ( XLY ) has the advantage over RTH for having a portfolio with double the number of underlying stocks at 53, which adds a layer of diversification. At the same time, the heavy tilt towards AMZN is still present while the fund has Tesla Inc. ( TSLA ) with a similar concentrate position at 20%.

We're not suggesting XLY is "better" than RTH, but simply that it's another option for a similar exposure. Notably, XLY's expense ratio at 0.10% compares to 0.35% in RTH.

There is also the iShares Global Consumer Discretionary ETF ( RXI ). Here, the structure addresses some of the perceived weaknesses we mentioned. First, AMZN's weighting is reduced down to 10% of the fund. There are also 159 stocks in the RXI portfolio as a step towards more diversification. We also find international stocks among top holdings like LVMH Moet Hennessy - Louis Vuitton SE ( LVMHF ) and Alibaba Group Holding ( BABA ).

Again, while not all these stocks are technically retail names, the argument we have is that they all benefit from similar high-level macro trends toward consumer spending. Over the past year, RXI has outperformed this group with a 20% return compared to 14% for XLY and 9% for RTH.

Final Thoughts

Ultimately we expect RTH to be trading higher this time next year. In the context of the current macro setup, the way we see it playing out is that economic conditions should remain resilient through 2024 while easing inflation allows interest rates to stabilize lower.

Evidence that the U.S. and global economy have successfully averted a recession in a "soft landing" scenario represents a positive backdrop for consumer spending and the key retail stocks within the RTH ETF.

On the other hand, the risk here to consider when investing in RTH or a similar equity ETF is that macro conditions deteriorate going forward. Weaker-than-expected economic growth defined by a sharp rise in unemployment and a slowdown in consumer spending would impact the earnings environment of major companies. Stocks could face a deep correction to the downside.

For all the reasons we discussed above, we don't see RTH as an exceptionally good choice to express a tactical or strategically bullish view of this segment of the market.

The fund's concentration in AMZN is excessive in our opinion, considering it's a major stock that most investors likely already have exposure to from other large-cap ETFs. For someone very bullish on AMZN, a position in the stock directly may make more sense within a diversified portfolio.

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