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All Contents © 2018The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| October 17, 2017
It’s the start of earnings season, which means bank stocks and other financial stocks have been thrust into the spotlight once again. Banks help kick off each quarter’s run of earnings reports, first by majors such as Bank of America (BAC) and JPMorgan Chase (JPM), then followed by regional and community banks.
By and large, bank ETFs are among the most direct ways you can invest to express confidence in the U.S. economy. Robust economic activity means more business for banks – more mortgages, auto loans and business loans, as well as spending via personal credit.
As America’s economy improves, the Federal Reserve should continue to hike its target for the fed funds rate, which over time should lift interest rates. (The fed funds rate currently stands at a range of 1%-1.25%.) Rising rates, in turn, help banks by improving their net interest margin; that is, the spread between what banks pay out in interest on deposits and what they earn in interest from mortgages and other loans. It’s no guarantee – higher rates can also dissuade consumers from taking out loans – but broadly, rising rates are viewed as bullish for bank stocks.
Bank stocks and other financial stocks can provide strong portfolio growth as the economy expands. However, there’s more than one way to invest in financials, depending on what your investment goals are and how much risk you’re willing to assume. These six bank ETFs provide varying ways to gain exposure to the financial sector.
Data is as of Oct. 16, 2017. Click on ticker-symbol links in each slide for current share prices and more. Yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Share price: $51.36
Market value: $892.6 million
Dividend yield: 1.4%
Expenses: 0.35%, or $35 annually on $10,000 invested
Most options for broad exposure to the nation’s biggest banks typically involve wide financial-sector ETFs that include insurers, investment companies and other non-pure plays, or funds that also include a heavy smattering of regional exposure.
However, the PowerShares KBW Bank Portfolio is one of just a few funds that provides access specifically to American mega-banks and big regionals.
The KBWB holds just 24 stocks, including the “Big Four”: Bank of America, JPMorgan, Citigroup (C) and Wells Fargo (WFC). And as one would expect in such a concentrated portfolio, those larger companies make up a significant portion of the fund – about 32% among the four of them.
However, KBWB’s modified market-cap weighting system ensures that larger regionals – which are a mere fraction of the size – still carry significant heft. For instance, BofA, which has a market capitalization of $276 billion, is the top weight at 8.1%, but Buffalo-headquartered M&T Bank (MTB) is a 4% weight despite its relatively modest $25 billion market cap. This helps reduce single-stock risk to a small degree.
Share price: $56.41
Market value: $10.6 billion
More growth-minded investors might want to think smaller about their bank-stock exposure.
Regional banks benefit from many of the same drivers as larger financials, such as rising interest rates helping to bolster net interest margin. However, there’s also potential in the form of mergers and acquisitions. The commercial banking space has been shrinking for more than a decade, from 7,870 banks in 2002 to 5,102 in 2016. Yes, the financial crisis of 2007-09 shook out some weaker hands, but the number of FDIC-insured commercial banks in the U.S. has been falling even as the industry has recovered. Some of that consolidation has come as larger regional banks swallow up smaller players.
Thus, there’s allure in funds like the SPDR S&P Regional Banking ETF, which holds more than 100 such companies, mostly in the mid- and small-rap ranges.
There are risks, of course, such as the fact that regional banks’ health can ebb and flow along with the health of their respective regional economies. But, holding a diverse fund that spans all parts of the country helps reduce that concern. So does KRE’s equal-weighting methodology, which levels out all holdings upon each rebalancing, ensuring no single stock’s failure can deep-six the entire fund.
Share price: $52.92
Market value: $326.2 million
Dividend yield: 1.3%
Investors who want to get really aggressive on the bank front, especially to exploit the potential for share-price spikes thanks to acquisitions, can consider the First Trust Nasdaq ABA Community Bank Index, which invests in smaller regional and community banks.
This First Trust bank ETF holds roughly 170 stocks, and to give you an idea about size, understand that the median market cap for the aforementioned SPDR S&P Regional Banking ETF sits at $6.7 billion, while the average QABA constituent is a mere $2.1 billion. And while just 37% of KRE’s portfolio is dedicated to small- and micro-cap stocks, more than 80% of QABA’s assets are invested in these smaller companies. In fact, QABA’s benchmark index automatically excludes the 50 largest banks or thrifts (including holding companies) based on asset size.
While QABA is market-cap weighted, there are no serious overweights to worry about right now. East West Bancorp (EWBC) – the parent of independent commercial bank East West Bank, which operates out of California – is the top weight at 3.3%. And despite its focus on small caps, QABA boasts a smaller standard deviation (a volatility measure) than KBE and KRE over the past three years.
Share price: $121.54
Market value: $1.5 billion
The iShares U.S. Financial Services ETF has a broader mandate than the previously listed ETFs, targeting not just commercial banks, but also asset managers and even credit card companies, among others. It’s a way to invest heavily in the banking industry while also benefiting from the growth of other companies that share similar tailwinds as banks.
You still get big bank exposure, with the Big Four alone making up nearly 30% of the fund, and pure-play banks combining for 55% of all assets.
But you also get access to the likes of Visa (V) and MasterCard (MA), which thrive from increased transactions amid a broader economic upturn. Credit card companies, too, have their own growth appeal as Americans increasingly walk away from cash – a trend that has marched on for years regardless of economic conditions. You also get to invest in companies such as Goldman Sachs (GS) and Morgan Stanley (MS), which lend to corporate clients much like regular banks, but also underwrite equity and debt, and provide investment management services, among other things.
That provides a little more protection against bank-specific downturns.
Share price: $26.29
Market value: $167.2 billion
Dividend yield: 1.5%
The Financial Select Sector SPDR Fund (Kip ETF 20 member) is far and away the largest financial ETF by assets under management, at $28.2 billion – more than quadruple the next-closest fund, the Vanguard Financials ETF (VFH).
It’s also far more diversified from an industrial perspective than the previously discussed ETFs. Translation: There’s even less bank exposure.
Pure-play banks make up just 44% of this fund, with the lion’s share coming from the Big Four and their combined 32% weight. But while JPMorgan is a massive overweight at 10.6% of assets, it’s not the biggest – that title goes to Warren Buffett’s Berkshire Hathaway (BRK.B, 11.3%), making up nearly all of XLF’s “Diversified Financial Services” allocation. The rest of the fund is invested across capital markets and consumer finance companies, much like IYG, but also includes a 20% holding in insurers such as Chubb (CB) and American International Group (AIG).
Insurers, while certainly far afield from banks, can similarly benefit as rates rise by investing their money into higher-yielding bonds.
Share price: $41.78
Market value: $351.4 million
Dividend yield: 1.2%
If you like the idea of wide financial exposure, but you don’t like the idea of any single stock – even one lorded over by Warren Buffett – making up such a large portion of a fund, the Guggenheim S&P Equal Weight Financials ETF should be more up your alley.
The RYF holds the same group of 67 securities as the aforementioned XLF; however, it equally weights the portfolio at every rebalancing, throwing market capitalization out the window. That’s how you get top holdings like regional bank Comerica (CMA), which is a bottom-third weight in the XLF. But there’s not much in the way of bragging rights there – CMA is just 1.6% of the fund, which is a mere basis point ahead of Charles Schwab (SCHW) and T. Rowe Price (TROW). (A basis point is one-hundredth of a percentage point.)
While this weighting system greatly eliminates the risk of a sudden collapse in, say, Berkshire or JPMorgan, it does skew the industry allocations significantly. Namely, insurance (33.7%) and capital markets (30.1%) are the biggest hitters in the fund.
And banks? They’re relegated to just more than a quarter of the fund.
That makes the RYF a so-so way to express your bullishness on banks … but a strong way for the risk-averse to go long American financials.
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