FDN First Trust DJ Internet Index Fund

The third quarter earnings season has not been an impressive one for the technology sector. The segment was among the biggest disappointments this earnings season after a decent run for two consecutive quarters in fiscal 2012.

Weak foreign revenue growth due to decreased international demand, coupled with reduced domestic business spending on the I.T sector were the major reasons for the below- expectations performance of the sector. Also, the strengthening U.S. Dollar against other major currencies was an added negative for the sector as exports for most I.T. companies were hit hard (read 3 Energy ETFs for America's Production Boom).

The story for the internet industry has certainly not been much different, though as of late it has comparatively fared better than most of its technology sector counterpart industries. Furthermore, the industry has come a long way from the dark days of the dotcom burst which shook its very foundations (read Volatility ETFs Winning on Fiscal Cliff Turmoil).

Nevertheless, speaking in general terms, the internet industry is characterized by free entry and exit of firms and huge inter-segment rivalry among the competing firms. These factors tend to decrease profit potential arising out of severe competition. However, lack of transparency in terms of price mechanism of products and offerings, make it difficult to quantify the impact of new entrants in the industry unless it is actually realized.

The fact that none of the industries from the tech sector make it to the ‘Very Attractive’ category as per Zacks Market Strategy report, sums up the current scenario of the sector. However, it is also prudent to note in the context of the article, that the Internet industry makes it to the ‘Attractive’ category of the Zacks Market Strategy Report and is expected to outperform the market in the near to medium term (see Do Country ETFs Really Provide Diversification?).

Given this, a look at a top ranked internet ETF could be the way to target the best of the segment with lower levels of risk.

About the Zacks ETF Rank

This can easily be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.

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, Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.

Using this strategy, we have found an ETF Ranked 2 or ‘Buy’ in the internet industry which we have highlighted in greater detail below.

First Trust Dow Jones Internet ETF (FDN)

Launched in June of 2006, the internet ETF—FDN-- tracks the Dow Jones Internet Index before fees and expenses. The index measures the performance of companies who primarily earn a majority of their revenues from the internet business and have a trading history of at least three months.

The ETF holds 41 stocks with no individual stock accounting for more than 10% of total assets. The index is market capitalization weighted adjusted for float. Google, Inc (9.91%), Amazon.com Inc, (7.20%), eBay, Inc (6.64%) and Priceline.com Inc (5.57%) are some of its top holdings (see more in the Zacks ETF Center).

Although the ETF seeks to limit its exposure within the geographic territories of the U.S., it is indirectly exposed to a variety of emerging as well as foreign countries. The reason for this is that most internet companies derive a bulk of their revenues from overseas markets; therefore these stocks are bound to be impacted by the cyclicality in these nations as well.

FDN has added about 17.5% so far this year (as of 30^th September 2012) primarily thanks to the splendid performance of the ETF in the 1^st and 3^rd quarter after a brief bearish bias in the 2^nd quarter of fiscal 2012. However, on a one year look, the ETF seems to have fared even better adding about 30% for the time period (as of 30^th September 2012) (read Top Zacks Ranked Healthcare ETF in Focus).

It also has a decent asset base of $482.48 million and it averages around 109,000 shares traded each day. Thus, it seems to be well poised in terms of popularity and liquidity. Although, at 60 basis points, the ETF seems to be a little pricey, especially when it is compared to a Morningstar category average of 54 basis points.

We look for this fund to consider its solid performance track record heading into 2013, especially when compared with other tech ETFs. Currently, FDN has a Zacks Rank of 2 or ‘Buy’ with a Medium risk rating.

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