iShares Dow Jones US Basic Mater. (ETF) (AMEX:IYM)

Industrial sector has been the backbone of any economy; the situation is no different for the world’s largest economy, the U.S. Over the years, this sector has delivered many a times when it mattered and pulled out the American economy out of trouble. There are a lot of firms in the U.S ranging from large corporations to small enterprises that dabble in various areas of this sector.

iShares Dow Jones Basic Materials Index Fund (IYM) is such a fund which has invested 90 percent of its assets in the industrial sector. The fund consists of 76 firms and is heavily skewed towards the chemical sector with 53 percent commitment. The rest is spread across sectors like steel, aluminum, paper products, and mining.

The fund with a 0.48% expense ratio returned 17% last year. This figure looks attractive but when compared with iShares newly launched S&P Global Material Index (MXI) pales in comparison in all counts. Although the expense ratio is same, MXI returned 30% last year and is less risky with assets distributed equally among mining, chemicals, metals and paper sector. This internal competition alone sets IYM in back foot.

The huge reliance in chemical industry will be IYM’s undoing the coming year as the sector is set to slow down to a growth rate of 1.9% from 4.9% it posted in 2006. The main reasons for this is the unreliable natural gas prices – which is the feedstock for 90 % of the materials, increasing electricity cost, reliance on a monopolistic railroad system for transportation. The solutions for these are complicated and will take time to reflect in fortunes of the firms as it involves steps ranging from political wrangling to restructuring of firm to contain cost.

Thus both internally and externally the fund is ill equipped to face the coming year. If internally it is the competition from peers like MXI that is making the fund unattractive, then externally the composition of the fund is loaded against the evolving macro economic scenario.