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The flurry of unidentified objects that have been shot down over North America this month could bring yet another boost to aerospace and defense stocks, but investors looking to use ETFs should be aware of some key differences between the largest funds. The U.S. shot down a fourth unidentified object on Sunday, as the administration takes a more aggressive stance after a suspected spy balloon from China flew across much of the country during the first days of February. These events are heightening tensions with China and, in turn, easing some fear among investors that the looming debt ceiling fight in Washington will damage the outlook for defense contractors working hand-in-hand with the military. “These incidents raise the likelihood, in our view, defense spending will not be cut, and perhaps be increased,” Roman Schweizer, analyst at Cowen, said in a note to clients on Sunday. Credit Suisse analyst Scott Deuschle, who upgraded the investment outlook for the defense sector to positive on Feb. 6, agreed with that position in a note to clients on Monday. “We believe these events are likely to reduce the willingness of Congress to use the DoD budget for political purposes, and instead drive consensus toward continued budgetary support. Specifically, we highlight that geopolitical tension/anxiety has historically been the driving force behind past defense budget trends, and we expect this time to be no different,” Deuschle said. While defense stocks have outperformed the broader market over the past year, in part due to the war in Ukraine, the latest shoot downs don’t appear to have significantly moved the sector. The three major ETFs in the industry had an average price return of less than 1% last week, albeit in a week when the broader averages declined. Here’s a look at the key differences among these ETFs. The biggest fund on the market is the iShares U.S. Aerospace & Defense ETF (ITA) , with about $5 billion in assets under management. The fund is competitively priced, with an expense ratio of 0.39%, and is weighted by market cap. The fund also hit its highest level since Feb. 2020 on Monday morning. One potential drawback is that the fund is heavily concentrated in just a few stocks. The top five holdings account for more than 50% of the fund, with Raytheon Technologies alone accounting for more than 20%. This means that a company-specific issue at Raytheon could lead the fund to suffer, even if the industry as a whole performs well. Another market-cap weighted fund is the Invesco Aerospace & Defense ETF (PPA) . One key difference for the Invesco fund is that it limits the size of any one stock in the portfolio to 10% at the time of rebalancing. The fund currently has no stock with more than a 10% weight in the portfolio, according to FactSet. The Invesco fund also has more stocks in its portfolio, including truck manufacturer Oshkosh Corp. and industrial company Ball Corp. That greater diversity in the fund does come with a higher price tag, however, as the Invesco ETF has an expense ratio of 0.58%. The third fund on the market is the SPDR S & P Aerospace & Defense ETF (XAR) . This ETF is equal weighted, with no single stock taking up even 5% of the portfolio. While the equal weighted fund does avoid some of the company-specific risks of a more concentrated portfolio, it also gives investors greater exposure to smaller companies that could be heavily reliant on a small number of government contracts. The SPDR fund, with an expense ratio of 0.35%, has the best total return of the group so far this year, at 7.15% — CNBC’s Michael Bloom contributed to this report.
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