FDIS ETF: Unattractive Broad Exposure to Consumer Discretionary Sector (NYSEARCA:FDIS)

When looking at more cyclical areas of the market, the consumer discretionary sector offers great long-term investment opportunities. While Amazon is the biggest player, the outlook for a number of companies from different industries in this sector remains generally positive despite challenges such as cost pressures and a slowing economy.

The Fidelity MSCI Consumer Discretionary Index ETF (NYSEARCA:FDIS) is one of the funds covering the sector. Its performance was positive, generally outperforming other ETFs covering the sector, but lagging the S&P 500 and with the typically high volatility seen in this sector.

While I believe a fund like FDIS can continue to deliver reasonable returns over the long term, I believe a more selective allocation to this sector is appropriate as long as macroeconomic uncertainties persist, given that this sector is closely linked to consumer confidence. Having said that, a A fund like FDIS that offers broad exposure to the consumer discretionary sector may not offer the best risk-reward approach.

ETF Description and Highlights

FDIS is an exchange-traded fund that provides exposure to large, mid-sized and small-cap US companies in the consumer discretionary sector by tracking the investment performance of the MSCI USA IMI Consumer Discretionary 25/50 index.

This index includes industries in the broader consumer discretionary sector such as automotive, apparel, consumer services and retail. Companies are weighted based on market capitalization, following a capping mechanism where no constituent exceeds 25% of the index, and the aggregate weight of all constituents with individual weights greater than 5% cannot exceed 50% of the index.

FDIS has $1.7 billion in AUM, diversified by market cap, with small caps and micro-caps accounting for approximately 17% of holdings. For reference, the Consumer Discretionary Select Sector SPDR ETF (XLY), the largest ETF covering the sector, is much more geared toward larger caps, with small caps accounting for just 1.7% of total assets. Another ETF covering this sector that will be used in the analysis for comparison is the First Trust Consumer Discretionary AlphaDEX ETF (FXD), with $1.5 billion in AUM and a stronger focus on mid- and smaller-cap companies, where allocated 84% of total assets. .

As of August 30, 2024, FDIS’ top ten holdings are Amazon (22.1%), Tesla (11.1%), The Home Depot (6.6%), McDonald’s (3.8%), Lowe’s (2, 6%), Booking Holdings (2.4%), TJX Companies (2.4%), Starbucks (2.0%), Nike (1.9%) and Chipotle (1.4%), representing 56% of fund, where we see large allocations to Amazon and Tesla, reflecting their large market caps. , as well as significant positions in home improvement retailers Home Depot and Lowe’s as well.

From an industry perspective, FDIS’ largest allocation is to Broadline Retail, with 24.7% of total shares, driven by its allocation to Amazon, similar to XLY, where Amazon accounts for nearly 21% of the holdings. The exception is FXD, with a modest allocation of just 1% to the internet retailer.

The second largest allocation by industry is to automakers at 14.5%, led by a large position in Tesla and smaller holdings in GM and Ford at nearly 1.0%. Meanwhile, XLY has more exposure to this segment, with 19.3% of total assets and a 15.8% allocation to Tesla. FXD is also underweight in this industry at just 3.6%. It is followed by Restaurants, where FDIS has a 10.3% exposure, almost the same as XLY, thanks to positions in MacDonald’s, Starbucks and Chipotle, both ETFs overweight to FXD, which has only 4.0% invested in segment.

FDIS also has significant exposure to Home Improvement Retail at 9.6%, compared to 10.5% for XLY and 0.5% for FXD, and to Travel & Leisure with holdings of 10.3%, similar to XLY but underweight compared to 17.9% for FXD.

Lower profitability along with lower valuation

FDIS’s bias against smaller companies has resulted in lower measures of profitability for the total portfolio compared to XLY, as measured by EBITDA and net income margins, FCF margin and return on assets (ROA). For example, EBITDA margin fell by almost 2.3%, according to my estimates, dragged down by lower exposure to larger and more profitable companies such as MacDonald’s (53.5%), Booking Holdings (31.2%) , Marriott International (66.1%), Hilton. (53.8%) and Yum Brands (37.0%). The reverse applies to a comparison with FXD due to FXD’s underweight allocation to these companies. Meanwhile, all three ETFs are well below the average return of the S&P 500, given the higher margins seen in sectors such as technology,

While the growth profiles of both FDIS and XLY are similar, FDIS trades at a relatively low price-to-earnings ratio of 22.17x compared to 23.8x for XLY. This is heavily influenced by FDIS’s underweight allocation to Tesla, which trades at a high price-to-earnings ratio of 62.2x, and to a lesser extent, lower exposure to Chipotle (52.1x) and TJX ( 28.1x), while overweight positions in smaller names such as Toll Brothers (9.1x) and Williams Sonoma (16.9x) also contributed to this valuation gap.

Source: Morningstar, Seeking Alpha and author’s estimates

Morningstar, consolidated by the author

Morningstar, consolidated by the author

Of course, this high volatility is driven by uncertainties in the consumer discretionary sector with a confluence of factors. First, on the positive side, the outlook for Amazon, by far the most prominent player in the sector, is generally positive as it continues to expand its e-commerce business, while its AWS division benefits from growing demand for its cloud offerings.

Beyond Amazon, the rest of the consumer discretionary sector is navigating a mixed environment. Hotels and resorts are seeing a post-pandemic recovery, while demand for renovation and DIY offers a positive outlook for home improvement retailers. On the downside, high interest rates have reduced demand for high-priced products, and labor and raw material costs have pressured margins for retailers and restaurants.