Wednesday, May 17, 2006

Deconstructing PKB Building & Construction Portfolio

Recently Roger Nusbaum wrote an article for about new ETF's that cover the homebuilder sector: Homebuilders SPDR (XHB) and Dow Jones U.S. Home Construction Index Fund (ITB).

Before these funds existed there was the Powershares Dynamic Building & Construction Portfolio (PKB). Many people complained that (PKB) didn't have enough concentration in homebuilders to be an effective proxy for the homebuilding sector. Those sorts of complaints remind me of the person who returns a newly purchased hammer to Home Depot (HD), complaining that it isn't very good at putting screws in. (He should have bought a Klein Tools Ratcheting Screwdriver instead.)

The Powershares fund, as its name suggests, is about Building & Construction. It is not about homebuilders. While homebuilders are part of the building & construction industry they are certainly not the entire industry.

Complaining that PKB isn't declining fast enough relative to pure homebuilding ETFs, suggests that the person complaining did not read the prospectus and/or the PKB portfolio holdings. This all goes back to the critical sucess factor of understanding why things work. Memorizing formulas only gives the appearance of competence.

Looking at the holdings would show that the Dynamic Building & Construction Intellidex is currently about 30% Homebuilding stocks. As a Dynamic index, the Intellidex is will try to weight itself towards stocks with the greatest potential for capital appreciation. That means that it is going to underweight/exclude stocks that the black box algorithm expects will underperform. Each quarter the index components change. For example, based on SEC documents (Form N-Q) on January 31 2006, the PKB fund owned shares of Caterpillar (CAT), Building Material Holding Corp (BMHC), and SCP Pool Corp (POOL) while it did not own any shares of Lowes Stores (LOW).

Investing in Powershares Dynamic funds is a bet that the quant AMEX Intellidex algorithm will outperform passive indices. Based on several years of experience it does seem that the BlackBox can beat passive indexes. The best use of the Building & Construction fund is as tactical investment to capture the increased building and construction activity that happens in the early part of an economic expansion. If you want to bet on homebuilders, stick to XHB.


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