Know What You Own: Investing in the Power of the Consumer?

What lies beneath the XLY

• The S&P 500 Consumer Discretionary Select Sector ETF (XLY) is largely driven by two companies, Amazon and Tesla, which make up a third of the weight and account for half of the risk.
• Neither Amazon nor Tesla is representative of the consumer discretionary sector. Amazon is more correlated with the tech sector than the consumer sector, and Tesla is concentrated on a single product category and not representative of the sector as a whole.
• Syntax’s Stratified Consumer Index more accurately captures the growth of the entire consumer sector, allocating weight evenly across only those companies with direct ties to consumer products. This was highlighted in November when the average consumer stock rose 8.8% and the Stratified Consumer Index rose 11.0%. In contrast, the XLY only gained 0.9% due to the poor performance of Tesla (-14.8%) and Amazon (-6.6%)

Exhibit 1: S&P 500 Consumer Discretionary Select Sector ETF (XLY) – Contribution to Risk (%)

The XLY tracks the S&P 500 Consumer Discretionary Select Sector Index which allocates weight relative to the market caps of those stocks in the S&P 500 that the Global Industry Classification Standard (GICS) classifies as Consumer Discretionary companies. A key selling point of the XLY is to enable investors to capture and benefit from the growth and prospects of the overall consumer discretionary sector. While the fund is widely owned (the ninth largest sector ETF at $14 bn as of 30 September 2022), investors may not fully appreciate their actual sector exposures when they allocate to the XLY.
The ten largest holdings of the XLY are shown in Exhibit 2 below. In aggregate, these ten positions comprise 66.3% of the portfolio weight, with the largest two holdings, Amazon, and Tesla accounting for 34.3%.

Exhibit 2: Concentration Problem – Ten Largest Holdings of XLY

Exhibit 3: Amazon and Tesla are 35% of the weight and 50% of the risk of XLY

While a 34% weight in only two positions is highly concentrated for a sector ETF, the concentration problem is further compounded due to Amazon and Tesla’s above average volatility. Amazon has an annualized volatility of 49.9%, whileTesla’s is even higher at 66.2%. Both stock’s annualized volatility is significantly higher than the 43.9% average volatility for the consumer discretionary sector.When large portfolio weights are allocated to highly volatile stocks, those stocks account for a greater percentage of the portfolio’s daily volatility. In the case ofXLY, Amazon and Tesla account for approximately 50% of the ETF’s risk.

XLY’s over reliance on two companies becomes more problematic, given that neither Amazon nor Tesla are representative of the whole consumer discretionary sector. We leveraged the granular data in Syntax’s Affinity platform to analyzeAmazon’s product line classifications and the percentage of associated revenue of each (Exhibit 4). Only 47.5% of sales come from Amazon’s online stores. The other half of its revenues were generated mostly from platform fees, subscription services, marketing and multimedia, which are not as strongly related to consumer discretionary business risks.

Exhibit 4: Amazon’s Product Line Classifications (by Associated Revenues)

In Tesla’s case, as a manufacturer of luxury automobiles, it is easier for the company to be classified and treated as a consumer discretionary stock with 82% of its revenues derived from direct electric vehicle sales (Exhibit 5). However, the narrow nature of the product category (e.g., electric vehicles as a relatively small percentage of total vehicle sales in the US) means that Tesla is not representative of the entire consumer discretionary sector. Instead, its share price is largely driven by the idiosyncratic nature of its business and its management team, which is reflected in its valuation. Automobiles as a business line represent 16.2% of the consumer discretionary sector, of which Tesla is 12.8 percentage points or 79% of the total weight. As reference point, the weight of Ford and GM in the index are 1.7% and GM 1.8%, respectively, even though both companies’ revenues exceed Tesla’s.

Exhibit 5: Tesla’s Product Line Classifications (by Associated Revenues)

As shown is Exhibit 6, the market views and treats Amazon more like the average information technology company than the average consumer discretionary stock. Amazon’s correlation with the S&P 500 Equal Weighted Consumer Discretionary Index (RCD) is 0.50, whereas the correlation with the S&P 500 Equal Weighted Information Technology Index is 0.67. In other words, Amazon is not particularly representative of consumer discretionary risks, yet it still accounts for 18.7% of the XLY’s weight and 23.9% of its risk.
We see a similar case with Tesla, which has a relatively low correlation of 0.45 with the S&P 500 Equal Weighted Consumer Discretionary Index (Exhibit 6) and approximately the same correlation of 0.40 with the S&P 500 Equal Weighted Information Technology Index.

Exhibit 6: Correlation of Amazon and Tesla with GICS Sector Indices

Therefore, it is evident that Amazon and Tesla, the largest two positions in the XLY, which make up approximately half of the ETF’s daily movements, are not representative of the consumer discretionary sector. This is far from ideal for investors that wish to get exposure to the sector by allocating to XLY.
In November 2022, the average stock in the S&P 500 Consumer Discretionary sector rose 8.5%. In other words, it was a stellar month for consumer stocks — however, the XLY only rose by approximately 1.0%. The primary reason was that the ETF’s performance was dragged down by Tesla and Amazon, which fell 14.8% and 6.6%, respectively in November. These two stocks not only created a significant headwind for performance of the overall portfolio, but their relatively larger weightings also outsized the rest of the ETF’s holdings, many which recorded very strong returns in November.

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As an alternative, the Syntax Stratified Consumer Index addresses the risk concentration issues inherent in the XLY by allocating exposure equally to each consumer segment. The result is an index which is representative of all the business opportunities in the consumer sector. The effectiveness of the Stratified Consumer Index to capture the performance of all consumer stocks was highlighted by its 11.0% return in November 2022 (Exhibit 7).

Exhibit 7: S&P 500 Consumer Discretionary Index vs Syntax Stratified Consumer Index

Important Information

This document is for informational purposes only and is not intended to be, nor should it be construed or used as an offer to sell, or a solicitation of any offer to buy, any security. Additionally, the information herein is not intended to provide, and should not be relied upon for, legal advice or investment recommendations. You should make an independent investigation of the matters described herein, including consulting your own advisors on the matters discussed herein. In addition, certain information contained in this informational piece has been obtained from published and non-published sources prepared by other parties, which in certain cases have not been updated through the date hereof. While such information is believed to be reliable for the purpose used in this informational piece, such information has not been independently verified by Syntax and Syntax does not assume any responsibility for the accuracy or completeness of such information. Syntax LLC, its affiliates and their independent providers are not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. Charts and graphs are provided for illustrative purposes only.Syntax®, Stratified®, Stratified Indices®, Stratified-WeightTM, Stratified Benchmark IndicesTM, Stratified SectorIndicesTM, Stratified Thematic IndicesTM, Affinity®, and Locus® are trademarks or registered trademarks of Syntax,LLC and its affiliate Locus LP. All third-party trademarks referenced remain the property of their respective holders and use of those trademarks does not indicate any particular relationship between Syntax and the third parties.

Index performance does not represent actual fund or portfolio performance and such performance does not reflect the actual investment experience of any investor. An investor cannot invest directly in an index. In addition, the results actual investors might have achieved would have differed from those shown because of differences in the timing, amounts of their investments, and fees and expenses associated with an investment in a portfolio invested in accordance with an index. None of the Syntax Indices or the benchmark indices portrayed herein charge management fees or incur brokerage expenses, and no such fees or expenses were deducted from the performance shown; provided, however that the returns of any investment portfolio invested in accordance with such indices would be net of such fees and expenses. Additionally, none of such indices lend securities, and no revenues from securities lending were added to the performance shown.