Pratt & Whitney, a division of United Technologies (NYSE: UTX ), announced Jan.
10 that it had secured a $194 million contract from the Department of Defense to
build engines for the F-35 stealth fighter. The announcement should reassure
investors that top-line revenue growth at the company hasnt evaporated despite
defense spending cuts. But before running out to buy its stock, you might want
to consider the alternatives. No, Im not talking about another stock, but rather
an exchange-traded fund like the Industrial Select Sector SPDR (NYSE: XLI ),
which is managed by State Street Global Advisors, along with eight other Select
Sector SPDRs. To date, State Street has gathered more than $20 billion in assets
for the nine index funds that comprise the S&P 500. As the funds website states,
Select Sector SPDRs have the diversity of a mutual fund, the focus of a sector
fund, and the tradability of a stock. All true. But why would someone whos
interested in owning United Technologies shares want to own a bundle of stocks
instead? Read on and Ill explain. Anyone who buys United Technologies stock is
getting arguably one of the best-run conglomerates in the country. In addition
to Pratt & Whitney, its brands include Carrier, Otis and Sikorsky. All very
well-known, the four combined for $42.6 billion in revenue in 2010. A $10,000
investment at the end of 2001 is now worth slightly less than $24,422 compared
to $13,312 for the S&P 500. UTX currently yields 2.5% and is part of the
Dividend Achievers index (companies increasing dividends in 10 or more
consecutive years), its easy to see why someone would want to own its stock.
Unfortunately, the past doesnt always predict the future. For this reason, some
investors might be better served exploring a more diversified ETF alternative.
In terms of volume, the XLI is one of the top 20 ETFs, with an average daily
volume of 16.9 million shares. More than 15% of its shares change hands on a
daily basis. Liquidity is not a problem. Its net assets as of Dec. 31, 2011,
were $2.71 billion. The fund has 61 holdings, with United Technologies being the
third-largest at 5.39%. Its top 10 holdings represent 49.3% of the overall
assets of the fund. For those of you who like the 2.5% yield United Technologies
offers, the ETFs yield is similar, at 2.2%. From a performance perspective, the
ETF unfortunately hasnt come close to meeting the returns of United Technologies
over the past decade, averaging 4.9% annually compared to 10.4% for the
conglomerate. On the bright side, it did outperform the S&P 500 in the same time
frame. Because of this underperformance, Ive widened my search to see if theres
something from an ETF perspective that fared better, is still broadly
diversified and has United Technologies in the top 10 holdings. The only ETF
that comes close is the SPDR Dow Jones Industrial Average ETF (NYSE: DIA ),
which seeks to provide results similar to the Dow Jones Industrial Average and
has 32 holdings compared to 30 for the index itself. In terms of
diversification, the 32 holdings cover all nine sectors, including industrials,
which is the largest representation at 21.5% of the fund. United Technologies is
the seventh-largest holding with a weighting of 4.66%. Its as blue-chip as there
is. Its 10-year annual return as of the end of December 2011 is 4.44%, 46 basis
points less than the XLI. Its a toss-up. Bottom Line Those chasing performance
at the expense of everything else, including risk, sometimes get stung. While a
550-basis-point difference in annual performance is definitely a big deal, its
important to remember that investing in a single company without any
consideration for diversification provides absolutely no protection against
disaster. If you like United Technologies as a company but dont have the funds
to buy 15 to 30 stocks equally as solid, both ETFs allow you to have your cake
and eat it too. And theres nothing wrong with that. As of this writing, Will
Ashworth did not hold a position in any of the aforementioned securities.
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