Background on the Boeing 737 Max
Within just a little over three years since its first flight on January 26, 2016, the Boeing 737 Max has already been involved in two fatal aviation accidents. The crash of Ethiopian Airlines Flight 302 on March 10 this year, came barely five months after another aviation disaster involving Lion Air Flight 610, which claimed 189 lives last October. As a result of these accidents occurring consecutively within such a short span of time, all Boeing 737 Max aircraft in operation worldwide have been grounded, as engineers attempt to reassess its safety features.
With Boeing 737 Max planes making up the bulk of Boeing’s delivery orders (560 out of 806 planes Boeing delivered in 2018 were the 737 Max), and its revenue stream, a combination of operational and legal risks, coupled with a loss of investor confidence have resulted in a plunge of its stock price. Boeing’s woes were further compounded when Indonesia’s Garuda Airlines announced on March 22 that it would cancel a major order worth $4.9 billion to purchase 49 Boeing 737 Max planes.
Boeing’s fortunes are unlikely to improve in the near future. Investigations into the Ethiopian crash have already thrown up new safety flaws in its aircraft, and raised troubling questions about why the company took so long to rectify safety issues. At the same time, more key customers seem unwilling to give Boeing the benefit of the doubt any longer. China, which agreed to purchase 300 aircraft worth $38 billion from Boeing in 2017, announced on March 26 that it has sealed a new $35 billion deal with Boeing’s biggest competitor, Airbus for a future delivery of 290 jets (A320 and A350 XWB) instead. By the end of March, Boeing has slashed one-fifth of its production of 737 Max planes, and lost over a tenth of its original value.
Consequences on the ETFs market
As one of the biggest drivers of the Dow Jones Industrial Average (DJIA) Index, the initial plunge in Boeing share prices resulted in the DJIA plunging over 200 points on the Monday (Mar 11) following the crash. In particular, the accident had far-reaching implications on major Exchange Traded Funds (ETFs) holding Boeing shares. Amongst those most severely affected were the iShares U.S. Aerospace and Defence ETF, SPDR Dow Jones Industrial Average ETF and Industrial Select Sector SPDR Fund which had significant exposure to Boeing.
iShares U.S. Aerospace and Defence ETF (ITA)
The $5 billion iShares U.S. Aerospace and Defence ETF (ITA) ETF was the worst hit by the Ethiopian catastrophe, with its 20.7% allocation to Boeing stocks being the highest in proportion amongst other ETFs. As such, Boeing is the main driver of the fund’s performance, with asset correlation analysis tools at Portfolio Visualiser suggesting that the two securities have a close positive correlation of 0.77. With a closing price of $209.12 on the last day of February, the fund has already lost more than 7% in value as it closed at $194.28 on March 22, suggesting that the plunging prices of Boeing had a strong correlation to a drop in the price of the ETF.
SPDR Dow Jones Industrial Average ETF (DIA)
The SPDR Dow Jones Industrial Average tracks some of the largest companies in the US including Boeing, 3M and Apple. With Boeing making up 9.74% of the fund, it is the largest component of the fund with United Health Group and 3M close behind at 6.59% and 5.48% respectively. Like the ITA, DIA plunged from $254.40 to $253.08 at its all day low on March 11 following the Boeing accident. While the fund did recover in the following week, it plunged over 1.3% from $259.58 to $256.00 on March 22, possibly corresponding to the announcement by Indonesia’s Garuda Airlines that it was cancelling its Boeing orders, leading to an initial drop in Boeing’s stock.
Industrial Select Sector SPDR ETF (XLI)
The Industrial Select Sector SPDR provides investors with an opportunity to invest in the US industrials sector which includes companies in the transportation and capital goods manufacturing industries. With Boeing contributing to 8.80% of the entire portfolio, like the other ETFs with Boeing as their biggest component, it was severely affected by Boeing’s woeful performance in the last month.As a result, the ETF’s price plunged over 2.5% from $74.90 before the accident to $73.00 on March 22, similar to other ETFs with significant exposure to Boeing.
Are ETFs the safe haven for investors?
Generally considered as a safe form of investment, ETFs invest in a wide range of securities and provides automatic diversification from the risk and exposure to any individual firm if investors were to purchase the company’s share alone. In particular, indexed ETFs are a form of safe and passive investment as they invest in the exact same securities as a given index, such as the S&P 500 and DJIA. As such, indexed ETFs replicate market trends and usually gain value as stock markets tend to be bullish over the long term. However, the Boeing accident has highlighted that a significant decline in a component of the fund could result in huge losses nonetheless, which may not be in line with general market trends.
Risks of industry sector ETFs
The Boeing incident has showed investors that ETFs can in fact be a risky addition to their portfolio, especially if the ETF has a very high exposure to a particular company in a specific sector. Looking back to the day after the crash of the Ethiopian Airlines Boeing 737 Max, the SPDR S&P 500 ETF actually rose in value from $274.00 to $275.69. This highlights the fact that the overall market actually gained that day and it was Boeing’s decline that was dragging down ETFs with significant exposure, reflecting the underlying risks of sector focused ETFs.
As industry sector ETFs allow investors to invest in stocks and securities in different industries such as energy, industrials and biochemicals, they are riskier as they tend to be exposed to sector-specific risks. Furthermore, these ETFs tend to hold securities of a smaller number of companies in the same sector as compared to broadly diversified ETFs like the S&P 500 ETF which holds a huge number of unrelated companies and aims to mimic the performance of the overall market. While investing in industry sector ETFs has its upsides, especially when investors are bullish that the particular sector can outperform the overall market, investors must also be aware of the greater individual risks they carry and hedge through diversification when appropriate.
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