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Homebuilder ETFs have been one of the great investing stories of 2012. Funds in this segment rode a wave of popularity higher as many investors changed their tune on the important space.

In fact, ETFs in this segment saw gains of over 65% on average in 2012, thoroughly crushing broad benchmarks in the time frame. Many had hoped that these gains would continue in 2013, as data was pretty strong across the housing market (see Homebuilder ETFs Continue to Rally).

Unfortunately though, after the bid up nature of the space in the later part of 2012, many investors paused before running up the segment further. Some concerns over a robust housing market recovery started to surface, while stock market highs led many to take some profits off the table in this space.

Thanks to this, housing ETFs have had a rocky start to 2013, with many underperforming the market. In fact, both are up less than the S&P 500 in YTD terms, suggesting that some might be wavering on the housing story this year.

Housing Outlook

Yet while there has been some more turbulence as of late, there is still reason to be optimistic going forward. This is particularly true when looking at some of the recent housing data to hit the market, as these data points have been much rosier, suggesting that the housing story still has a bit of room to run.

Recent existing home sales data showed that seasonally adjusted annual rates came in just shy of five million. While this was a bit lower than the consensus, total supply remains below five months, a reduction of 1.5 months when compared to year ago figures (read Real Estate ETFs: Real Winners in 2013).

This suggests that supplies are increasingly tight in the market and that prices may begin to rise across the space. In fact, median prices increased 6.2% from February, putting the year-over-year rate at 11.8%, the best since 2005.

Good news was further confirmed by the recent new home sales report, which finished just two thousand units short of the consensus. While the miss of the consensus was disappointing, the homes on the market remains quite low, suggesting that more construction may be needed.

Additionally, the sales continue a solid trend for the market, as new home sales have continued to tick higher despite a modest increase in mortgage rates in the past few months. And to top things off, Barclays also upgraded the entire homebuilder sector, adding more bullish undertones to the market.

How to Play

Clearly, the broad housing sector is doing quite well, and it has fought through a recent bout of weakness. This could make the space an interesting target for investors seeking to ride a second leg up in the segment (see Homebuilder ETFs After Housing Data).

However, a broad look at the space could be the way to go, in order to strip out some company specific risk, and reduce volatility. In order to do this, investors currently have two solid ETF options, which we have highlighted in greater detail below:

SPDR S&P Homebuilders ETF (XHB - ETF report)

This fund follows the S&P Homebuilders Select Industry Index, providing equal weight exposure to 36 companies in the segment. Volume on this ETF is really good coming in just under six million shares a day, while the expense ratio is also quite solid at 35 basis points a year.

Despite these features of high volume and low expenses, investors should note that it isn’t a ‘pure play’ on housing. Instead, the ETF has just 27% of its portfolio in homebuilders, putting another quarter into building materials, and specialty retail, with household appliances (18%) rounding out the rest of the portfolio (see Is XHB a Better Housing ETF Play?).

For individual securities, the ETF is heavily skewed towards small and mid caps, as large cap firms only make up 11% of assets. And due to the equal weight nature of the fund, no one company dominates the holdings profile, as all make up less than 4% of assets.

In terms of performance, the ETF added about 5.8% so far in 2013. However, thanks to the fresh burst of good news, the fund added about 2.4% in April 23rd trading.

iShares Dow Jones US Home Construction ETF (ITB - ETF report)

This ETF tracks the Dow Jones US Select Home Builders Index, providing concentrated exposure to about 30 companies in the sector. The fund has great volume of about 4 million shares a day, charging investors 46 basis points a year in fees.

The fund is, unlike its XHB counterpart, almost entirely focused on the actual builders of homes, as these constitute about two-thirds of the exposure. Beyond that, specialty retail makes up another 11% while building materials account for another 9% as well.

In terms of individual stocks, most fall into the mid cap category, with small caps taking up about 30%, leaving large caps with just 12% of assets. The top three holdings account for nearly 28% of the ETF though, with (LEN - Analyst Report), (DHI - Analyst Report), and (PHM - Analyst Report), occupying these spots.

ITB was up about 4.2% so far in 2013, at least before the data release of April 23rd. The fund saw great trading in the early part of the session, gaining almost 3.8%-- and nearly doubling its YTD gain—in the process (read 3 Excellent REIT ETFs You Should Not Ignore).

Bottom Line

Despite a recent slump, homebuilder ETFs are roaring higher once more. Data is coming in at reasonable levels while some analysts are upgrading their targets for key companies in the segment.

So, after the breather in the earlier part of the year, we may be witnessing the start of the second leg higher in housing. While the trend can be played via individual stocks, a less volatile—but still great option—is to target homebuilder ETFs, as these can provide broad exposure to the positive situation in the housing market, which apparently still has some room to run.

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