First Trust DJ Internet Index: This Internet ETF Stalwart Is Finally Bought (NYSEARCA:FDN)

Tech stocks across the spectrum took a beating in 2022 as inflation and interest rates rose. However, new survey data shows that most economists predict that the Fed will suspend its rate hike campaign indefinitely. two additional 25-basis-point increases left the Fed Funds Rate slightly below its previously announced target of at least 5.25%. Along with this conflicting economic data Stocks, especially those highly sensitive to interest rate moves, are looking highly bullish, suggesting that any recession will be moderate with the Fed backing off soon.

So today I’m taking a look at a couple of my favorite old tech ETFs, the First Trust Dow Jones Internet Fund.NYSEARCA: FDN) and the Global X Cloud Computing ETF (CLOU) to see if the timing is right to start a position in either or both. This second article will focus on FDN, the larger and better established ETF of the two.

Overview

The First Trust Dow Jones Internet Index Fund is a 42-holding, top-heavy ETF with an above-average annual expense ratio of 0.51% and no dividends. From its inception in 2006 until the end of 2021, FDN has served as a reliable substitute with a more aggressive growth profile and lower yield (EPI), creating a solid tax-advantaged core technology holding. Its significant exposure to the biggest tech companies, such as Alphabet ( GOOGL ), Amazon ( AMZN ), and Meta ( META ), is traditionally viewed as a source of stability during market downturns, as its top 10 holdings (nine companies, as they include both) Google (GOOG) and (GOOGL) make up about 50% of the portfolio.

Stock option

FDN is compared to the Dow Jones Internet Composite Index, which selects the 40 largest companies traded on the NYSE or Nasdaq that derive at least 50% of their revenue from the Internet—a fairly broad and subjective requirement in today’s economy. at least!

Of these 40 stocks, 15 should be classified as internet commerce companies such as online retail, financial services, travel and social media, and 25 as internet services companies such as cloud computing, website development and enterprise software. Positions are then weighted in descending order by market capitalization and trading volume, with individual weights limited to a maximum of 10%.

Given this methodology, it’s no surprise that mega caps Alphabet, Amazon, and Meta occupy the top three positions and hold more than 25% of the combined weight. With such a large percentage of FTN dedicated to the three companies, I think another ETF may better suit your needs unless you believe GOOGL, AMZN, and META will rebound as the market recovers.

Risk

For sector ETFs, I strongly favor passive index funds because they won’t trade holdings based on the psychological motivation of fund managers or try to time the market by buying low and selling high, except for their annual rebalancing. benchmark index methodology.

One of my main concerns with ETFs like FDN that use indexes with such broad, subjective inclusion criteria is that they can sometimes blur the line between passive and active fund management. While the stock selection criteria of the Dow Internet Composite Index may sound somewhat rigid and well-defined, for fund managers “50% of the returns from the internet“.

This is also why I stay away from sub-sector ETFs, because the modern distinction between words like “technology”, “cloud” and “internet” is quite vague, and almost every aspect of the underlying technology and communications companies and their products are defined in a certain way. related to the Internet and its use. This may sound obvious, but the takeaway for investors is that even index-based ETFs can have portfolios that are arbitrarily selected by fund managers based on their view of the market.

In terms of sector exposures, we see FDN as having large allocations to tech-based communications and consumer-related stocks and low allocations to financials, healthcare and real estate. Looking at all of its holdings, it’s clear that FDN’s overall portfolio is actually quite risky compared to QQQ, with most of its positions outside the top ten being similar to holdings in ARKK or equally high-risk, high-reward tech funds. Potential for sales growth instead of profitability in areas such as SaaS, e-commerce and cyber security.

I’m a little concerned about the inclusion of names that have thrived during the COVID lockdowns, such as Cloudflare ( NET ), Teladoc ( TDOC ), DocuSign ( DOCU ), Pinterest ( PINS ), but faded due to high valuations without clear paths to profitability. About FDN’s risk profile. However, because it is linked to an index and not actively traded like ARK’s funds, investors can now benefit from a potential rebound as interest rate growth slows and the market recovers from a brutal 2022.

Performance

Let’s take a look at FDN’s historical total return compared to QQQ since its inception in 2006:

While FDN has outperformed QQQ over its long run, FDN’s drawdown from late 2021 to late 2022 has outpaced QQQ by a wide margin, with the same large-cap tech exposure that once served as a buoy down. . Shares of AMZN, GOOG and META lost more than the overall market last year, helping FDN’s QQQ underperform by 13%.

The result

I’m mostly a dividend growth investor focused on companies that offer growing income and growth at a reasonable price, so volatile, pure growth ETFs like FDN usually don’t tempt me. But after such a large, macro-based decline in internet-centric stocks in 2022, with interest rate growth slowing and stalling over the next few quarters, I see relatively limited downside for FDN at current levels and consider holding diversified tech. The ETF likes this as a smart way to capture the upside of the market’s gradual recovery.

Investors should expect high volatility as this stock recovers, and I expect the overall market to break past highs sooner than many FDN stocks. Still, with a recoverable valuation base, a high percentage of wide-moat, mega-cap tech holdings, and a long-term track record of performance against QQQ, I rate FDN a buy at current levels as a key diversified tech holding. long term investors.