Material Girls: Materials ETFs Look For More Upside

The Materials Select Sector SPDR (NYSE:XLB), the largest diversified exchange-traded fund tracking the materials sector, is up 9.1 percent year-to-date. XLB's 2016 is impressive not only because it puts the fund in third place among the sector SPDR ETFs, but also because XLB sagged 8.7 percent last year.

XLB has been buoyed not only by rebounding commodities prices, but also by mergers and acquisitions activity. For example, Monsanto Company (NYSE:MON), XLB's third-largest holding, is the target of a takeover by Germany's Bayer AG (ADR) (OTC:BAYRY), while Dow Chemical Co (NYSE:DOW) and E I Du Pont De Nemours And Co (NYSE:DD) are merging to become one of the largest chemicals makers in the world. Those three stocks combine for nearly a third of XLB's weight.

Materials Are Hot

Investors are acknowledging strength in the materials sector, as are analysts.

Investors piled into materials equity ETFs in May, with the $1.8 billion for the sector exceeding the net inflows of all other GICS sectors according to SSGA data. Though the materials sector of the S&P 500 has already been a bright spot in 2016, rising 9.3 percent year to date through June 10, S&P Global Market Intelligence thinks there's room for additional growth, said S&P Capital IQ in a note out Monday.

The research firm is bullish on the materials sector, noting that of the 26 materials stocks in the S&P 500, S&P Capital IQ has buy or strong buy ratings on 18. XLB is home to 26 stocks.

Looking For More Upside

Although the materials sector is one of the smallest sector allocations in the S&P 500, there is competition in this corner of the ETF space. For example, XLB and other cap-weighted materials ETFs are facing rising competition from smart beta materials ETFs. The John Hancock Multifactor Materials ETF (NYSE:JHMA) is part of that group.

Unlike its market-cap weighted peers, JHMA emphasizes smaller cap companies with relatively low valuations and high profitability. International Paper Co (NYSE:IP) and LyondelBassell Industries NV (NYSE:LYB) were heftier positions in JHMA than in XLB and FMAT. JHMA has a 0.50 percent expense ratio and has a wider bid/ask spread than its peers, added S&P Capital IQ.

JHMA debuted in late March and now has $5.3 million in assets under management. Although it employs a smart beta strategy, JHMA's valuation is slightly below that of XLB plus the Hancock ETF features a larger roster at 35 stocks. However, JHMA charges 0.5 percent per year compared to 0.14 percent charged by XLB.