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Zacks #1 Ranked Industrial ETF: IYJ

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With a global economy still struggling and a lackluster job market notwithstanding, the U.S. is seeing some growth, particularly in the industrial sector. This segment continued to gain traction in the first half of the year, suggesting that the chance of a double dip recession is low, especially given constant Fed stimulus (read: Three Industrial ETFs Outperforming XLI). 

Recent data also shows that industrial production is growing at a healthy pace, boosted by strong manufacturing, mining and utilities productivity. High demand for consumer durable goods, in particular motor vehicles, and replacement of traditional and high-tech business equipment will continue to drive growth through the reminder of the year.

However, the sentiments regarding the industrial sector have been turning negative of late given the concerns over America's political gridlock, intensifying European debt crisis and weak exports. Even in this case, the emerging market demand would not work in favor of this key segment (read: Get True Emerging Market Exposure with These Three ETFs).

Given the broad issues at play in the industrial space, a closer look at top rated funds in this space could be the way to go. This can be easily done by investing in the iShares Dow Jones U.S. Industrial Sector Index Fund (IYJ - Free Report) , which is a #1 Zacks ETF Rank (Strong Buy) fund.

We expect it to outperform its peers with a similar (low) risk level over the next year. Given this, the product could be worth a closer look by investors seeking more exposure to this important sector (read: Five Best Performing ETFs (So Far) in 2012).

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium, or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the U.S. industrial market, we have taken a closer look at the top ranked IYJ below:

iShares Dow Jones U.S. Industrial Sector Index Fund (IYJ)

Launched in June 2000, this fund has emerged as a strong winner in the entire industrial space, producing more than 49% in returns over the past three years. It is one of the largest and popular ETFs in the industrial space.

The fund seeks to match the price and yield of the Dow Jones U.S. Industrials Index, before fees and expenses. The stocks in the fund are mostly the large-cap companies from a number of sub-sectors including construction and materials, aerospace and defense, general industrials, electronic and electrical equipment, industrial engineering, industrial transportation and support services. 

With holdings of 23 securities, the product has a nice mix of portfolio with least attention (37%) paid to the top 10 holdings. General Electric (GE - Free Report) takes the top spot in the basket with 12% share, followed by United Technologies (UTX - Free Report) , and Union Pacific (UNP - Free Report) in order to round out the top three. Among others, the fund does not allocate more than 3% to any one company, suggesting wide diversification (read: Three ETFs With Incredible Diversification).

While the product puts a substantial 68% of its assets in giant and large companies, mid and small companies account for the remaining portion of the basket. As a result, the fund tends to be less volatile than many other products in the space. Additionally, the ETF has a mixed style box including growth, value and blend securities with a lower portfolio turnover of 6.0%.

Though a large part of the fund is concentrated on the industrial sector, it provides substantial exposure to technology, basic material and health care sectors as well (see more ETFs in the Zacks ETF Center). These diversification benefits outweigh industrial sector risk arising from product obsolescence, supply/demand imbalances, competition and government regulations.

IYJ has been able to manage assets of $561.6 million, returning around 13% year-to-date (as of September 12th) with a decent dividend yield of 1.11% annually. In addition, the product is often considered a high momentum (the change in the fund’s price over the past three months) ETF with value closer to 110, suggesting that it will continue to move higher relative to its counterparts (read: Do You Need a High Momentum ETF?).

The ETF is quite expensive, charging 47 bps in annual fees. It trades in good volume of more than 71,000 shares per day, suggesting a relatively small bid/ask spread. Nevertheless, returns are much more than the costs, making IYJ an interesting pick for investors looking for a top ranked industrial choice in the current market turmoil. 

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