This ETF Has a Solid Foundation

12/11/2012 7:45 am EST

Focus: ETFs

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and

Record low interest rates and a slowly recovering economy have meant that the US real estate market is regaining some of its lost luster, and this ETF is a good choice for playing the secular trend, writes Doug Fabian of Making Money Alert.

The mortgage market and homebuilding industries have been two of the top-performing sectors in 2012, and their recovery from the bottom of the 2008 real estate crisis appears to be gaining momentum. An exchange traded fund that lets you invest in both of these sectors is the SPDR S&P Mortgage Finance ETF (KME).
The fund seeks investment results that closely correspond to the price and yield performance, before fees and expenses, of the S&P Mortgage Finance Select Industry Index. That index features the mortgage banking, processing, and marketing segments of the US financial services industry.
To that end, the performance of the index is reflecting a strong recovery in the sector. While mortgage rates are at record lows, lending has tightened due to uncertainty about the economy.

Despite this heightened aversion to risk among mortgage lenders, KME is up 32.43% year-to-date. One reason for this surge is the inclusion of homebuilders in the ETF. Homebuilding has improved this year, with existing home sales, new residential construction, and building permit authorizations beating market expectations. These positive signs point to growth and new business for mortgage finance companies.

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The sector allocation is worth noting. The index's name gives the impression that the primary businesses it tracks consist of mortgage industry-related companies. But a closer look at the composition of the holdings reveals that 58.77% of the ETF includes property and casualty insurance companies. Other major holdings of the fund are homebuilders, 22.52%, and thrifts and mortgage finance companies, 18.71%.
KME is a well-diversified fund that consists of 45 holdings, each consisting of less than 4% of the portfolio. The five biggest holdings are: Ocwen Financial, 3.73%; Fidelity National Financial, 3.48%; Old Republic Intl., 3.16%; Arch Capital Group, 3.12%; and Ryland Group, 3.11%.
Recent indications are that the mortgage and homebuilding markets will keep moving toward full recovery in the next five years. While policy implications in Washington have tightened lending standards, a resolution in the near future should clear up some uncertainty and give another boost to KME.

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