Aerospace and defense ETFs beat S&P 500 as Middle East fears intensify

By Christine Idzelis

'Over the past year, a widening Middle East war has been our No. 1 risk to the bull market in stocks,' says one analyst

Hello! This week's ETF Wrap looks at aerospace and defense ETFs amid escalating tensions in the Middle East, comparing surging gains over the past year as well as the portfolios of the three biggest funds.

Please send feedback and tips to christine.idzelis@marketwatch.com or isabel.wang@marketwatch.com. You can also follow me on X at @cidzelis and find me on LinkedIn. Isabel Wang is at @Isabelxwang.

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Aerospace and defense exchange-traded funds are up this week, even as the U.S. stock market has broadly stumbled amid fears that fighting in the Middle East may spark a wider war.

"Over the past year, a widening Middle East war has been our No. 1 risk to the bull market in stocks," Ed Yardeni, president of Yardeni Research, said in a note dated Oct. 1. "For now, we are sticking with our subjective probabilities: 50% Roaring 2020s, 30% 1990s-style meltup, and 20% reprise of geopolitical turmoil reminiscent of the 1970s."

Iran's missile attack on Israel this week intensified geopolitical tensions in the Middle East, with the White House on Oct. 1 warning of "severe consequences." The conflict in the region has intensified about a year after Iran-backed Hamas launched a terror attack on Israel on Oct. 7.

While the S&P 500 SPX has fallen 0.7% so far this week, the iShares U.S. Aerospace & Defense ETF ITA, Invesco Aerospace & Defense ETF PPA and SPDR S&P Aerospace & Defense ETF XAR all held on to weekly gains even after retreating Thursday.

The three funds are the largest U.S.-listed ETFs focused on aerospace and defense stocks, according to Aniket Ullal, head of ETF research and analytics at CFRA Research. "The top three dominate" the category based on assets under management, each putting up strong gains this year led by the Invesco Aerospace & Defense ETF, he said in a phone interview.

Shares of the fund, which has around $4 billion in assets, have climbed 24.9% this year through Thursday to beat the S&P 500's gain by more than 5 percentage points, FactSet data show.

The ETF's outperformance over the past year is even stronger, surpassing the SPDR S&P 500 ETF Trust's SPY rise by almost 12 percentage points. The Invesco Aerospace & Defense ETF skyrocketed 46.6% in the last 12 months through Thursday, compared with a 34.7% jump for the SPDR S&P 500 ETF Trust over the same stretch.

The Invesco Aerospace & Defense ETF also beat the 44.6% gain posted in the last 12 months by the larger iShares U.S. Aerospace & Defense ETF, which has around $6 billion of assets. Both ETFs have climbed higher than the SPDR S&P Aerospace & Defense ETF's 43.5% over the past year through Thursday, according to FactSet data.

Two much smaller ETFs have seen even bigger gains over the last 12 months, with the Global X Defense Tech ETF SHLD shooting up 58.7%, and the First Trust Indxx Aerospace & Defense ETF MISL soaring 48.2%.

As for fees, the SPDR S&P Aerospace & Defense ETF, which manages around $2 billion of assets, is the least expensive of the three biggest U.S.-listed ETFs in the category, with an expense ratio of 0.35%. That compares with 0.4% for the iShares ETF. The expense ratio is 0.57% for Invesco's fund, according to a spokesperson for the firm.

Among the smaller funds, the Global X Defense Tech ETF, which has almost $560 million of assets, has an expense ratio of 0.5%, while the First Trust Indxx Aerospace & Defense ETF, which manages $90 million, is a bit more expensive at 0.6%, according to FactSet data.

Tech exposure?

There are some differences in the construction of the biggest aerospace and defense ETFs' portfolios, which shows up partly in the weightings of their largest holdings, according to Ullal.

The SPDR S&P Aerospace & Defense ETF seeks to track an equal-weighted index of stocks in those areas; the Invesco Aerospace & Defense ETF and the iShares U.S. Aerospace & Defense ETF each invest based on market-capitalization-weighted indexes, said Ullal.

While the aerospace and defense holdings of all three ETFs are mainly in the industrials sector, the Invesco Aerospace & Defense ETF is distinct in carving out an almost 6% weighting to information technology, he noted.

The Invesco Aerospace & Defense ETF's top four holdings as of Oct. 2 were Lockheed Martin Corp. (LMT), RTX Corp. (RTX), GE Aerospace (GE) and Boeing Co. (BA), all of which had a more than 7% weighting and fall within the S&P 500's industrials sector, according to data on the fund found on the firm's website. The fund's fifth-largest holding, Northrop Grumman Corp. (NOC) at a nearly 6% weight, also falls within industrials.

As for tech exposure, the Invesco Aerospace & Defense ETF holds shares of companies such as Palantir Technologies Inc. (PLTR), Amphenol Corp. (APH) and Teledyne Technologies Inc. (TDY), but they were much smaller than its top positions, data on Invesco's website showed.

Palantir, a software company whose customers include defense and intelligence agencies in the U.S. government, has soared around 128.5% this year through Thursday, FactSet data show.

Read: Oil prices turn higher for the year on risks to crude flow in the Middle East

'More top-heavy'

The top three stocks held by iShares U.S. Aerospace & Defense ETF each have heavier weights compared to the Invesco fund's largest positions.

The biggest exposure for the iShares ETF as of Oct. 2 was GE Aerospace, with an almost 19% weight, followed by RTX at more than 15% and then Lockheed Martin at slightly more than 11%, according to data on BlackRock's website.

"ITA is much more top-heavy relative to PPA," said Ullal, referring to the tickers for the ETFs.

Rounding out the top five holdings for the iShares U.S. Aerospace & Defense ETF were Axon Enterprise Inc. (AXON) and TransDigm Group Inc. (TDG), which also belong to the industrials sector. Shares of those companies had smaller weightings in the portfolio, each at almost 5%.

By comparison, all of the SPDR S&P Aerospace & Defense ETF's largest five positions as of Oct. 2 - Curtiss-Wright Corp. (CW), Axon Enterprise, L3Harris Technologies Inc. (LHX), Howmet Aerospace Inc. (HWM) and Lockheed Martin - carried a weight of almost 5%, according to data on the website of State Street Global Advisors.

What about flows?

Money has been flowing into the Invesco Aerospace & Defense ETF over the past year in particular, with the fund attracting almost $1.4 billion of inflows, according to FactSet data.

That's far more than the $263 million flowing into the SPDR S&P Aerospace & Defense ETF over the same period, and contrasts with $653 million of outflows from the iShares U.S. Aerospace & Defense ETF.

"They all have strong performance this year," said Ullal. But typically "flows don't react as quickly to events as returns do."

As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data

The good...

   Top performers                                                                                                                                                                       %Performance 
   Invesco China Technology ETF                                                                                                                                                         21.9 
   Xtrackers Harvest CSI 300 China A-Shares ETF                                                                                                                                         18.8 
   KraneShres CSI China Internet ETF                                                                                                                                                    17.5 
   iShares MSCI China ETF                                                                                                                                                               12.7 
   iShares China Large-Cap ETF                                                                                                                                                          11.2 
   Source: FactSet data through Wednesday, Oct. 2. Start date Sept. 26. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater. 

...and the bad

   Bottom performers                          %Performance 
   ProShares Bitcoin ETF                      -12.6 
   Grayscale Ethereum Trust                   -10.7 
   iShares Ethereum Trust ETF                 -10.6 
   Grayscale Ethereum Mini Trust              -10.4 
   YieldMax COIN Option Income Strategy ETF   -7.8 
   Source: FactSet data 

New ETFs

-- Roundhill Investments said Thursday that it listed the Roundhill China Dragons ETF DRAG, which seeks to provide exposure to China's top technology stocks.

-- Cambria Investment Management said Thursday that it plans to launch in December the Cambria Tax Aware ETF (TAX), which will "focus on U.S. stocks with value and quality characteristics and low or no dividend yield." The firm said that "by strategically managing its holdings, the ETF aims to generate capital appreciation without distributing high dividend income or taxable gains."

-- Calamos Investments announced on Oct. 1 the launch of the Calamos S&P 500 Structured Alt Protection ETF - October CPSO and the Calamos Russell 2000 Structured Alt Protection ETF - October CPRO, saying they provide "100% downside-protected exposure to their respective indexes" as well as "upside cap rates over a one-year outcome period."

Weekly ETF reads

-- Golden Dragon China ETF climbs sharply, heads for longest winning streak since April (MarketWatch)

-- Potential bitcoin ETF options could transform crypto trading and squeeze prices higher (MarketWatch)

-- How Nvidia's Monster Rally Broke Your Tech ETF (Wall Street Journal)

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