Mutual Fund News
BANKING ETFS: WILL IT BE DIFFERENT THIS TIME?
In 2017, certain financial services ETFs have received large inflows due to what CFRA sees as increased confidence that macroeconomic and political developments will drive these securities higher. Yet, if this were to occur, during a rising interest environment, the outperformance would be different than what occurred in prior rising rate prior periods in the past.
According to Sam Stovall, Chief Investment Strategist at CFRA, during rising-rate periods since 1970, the S&P 500 Financials sector has traditionally underperformed the S&P 500. He cited the -0.70 correlation between Fed funds rate and the yield curve (10-year yield minus the Fed funds rate), meaning that when short-term rates rose, the difference between long and short rates fell as inflations fears lessened. This time, however, financial stocks have soared.
Stovall thinks the reasons why may be two-fold. First, the financial sector is responding to the new President's pledge to reduce onerous regulatory pressures on the sector. Second, the Fed's rate-tightening efforts are designed not to "restrain," but to "recalibrate" the relationship between rates and inflation. Historically, the Fed funds rate has averaged about 1.50 percentage points above the year-over-year rise in inflation. Today, this relationship would imply that the Fed funds rate should hover near 3.8%, not the current sub-1.0% area. Therefore, Stovall thinks investors likely believe that because of a strengthening economy, the yield curve will steepen, which would ultimately benefit the profit margins' of those companies that "borrow short" and "lend long."
The diversified bank and regional bank subindustry outperformed the S&P 1500 index in 2016, climbing 19% and 32%, respectively. Yet, CFRA has STARS rankings on 40 diversified and regional banks, with Strong Buys (5-STARS) or Buy (4-STARS) on 14 of them. Bank of America (BAC 25 ****), JPMorgan (JPM 91 ****), SunTrust Banks (STI 60 ****) and Signature Bank (SBNY 159 ****) are some examples.
"Diversified banks can be big beneficiary of the above developments and a strengthening economy", explained Nick Kalivas, Senior Equity Product Strategist at PowerShares by Invesco to CFRA. "Regional banks already had a strong run and there is a perception diversified banks are being held back because of the regulatory challenges."
In ranking approximately 960 equity ETFs, CFRA combines holdings-level analysis with ETF-level relative attributes. An ETF is reviewed based on the valuation and risk considerations of the holdings as well as its expense ratio and bid/ask spread.
PowerShares KBWB Financial (KBWB 50 Marketweight), a financial ETF with $980 million in assets, pulled in $311 million of new money year to date through February 17, according to data on etf.com. At the end of January, assets were primarily split between diversified banks (42% of assets) and regional banks (41%), with smaller stakes in asset management & custody banks (11%) and consumer finance companies (4%). BAC, JPM and STI were among the fund's top-10 holdings. KBWB has a 0.35% expense ratio.
Meanwhile, Financial Select Sector SPDR (XLF 25 Overweight), a $25 billion ETF, expanded its asset base by $1.5 billion year to date. While banks (45% of assets) was the largest industry, predominantly through large-cap diversified banks, the capital markets, diversified financial services and insurance industries each had double-digit percentages of assets. XLF has a 0.14% net expense ratio.
A similar multi-industry offering, Vanguard Financials (VFH 63 Overweight) pulled in $475 million of new money, expanding its assets to $5.6 billion. Here too bank exposure (46%) is larger than the other industries, though regional banks are more heavily weighted due to the multi-cap nature of the portfolio. For example, mid-cap SBNY is a VFH holding but the bank is not inside XLF. Insurance and capital markets industries are each 10%-plus of the ETF's assets. VFH has a 0.10% expense ratio
In contrast, the asset base has shrunk in 2017 at a fellow SSGA offering SPDR S&P Bank (KBE 46 Marketweight). The $3.3 billion fund has $67 million in assets in net outflows in 2017. Unlike KBWB, XLF or VFH, KBE is an equally weighted portfolio. Yet, similar to KBWB, KBE has a 0.35% expense ratio and has 80%-plus of its assets in banks. KBE has more than 70% in regional banks, and a much smaller stake in diversified banks, making it quite different than the PowerShares product. Not surprisingly to us, KBWB underperformed KBE in 2016 but has done better year to date through February 17.
CFRA's reports on the above financial stocks and ETFs can be found on this platform.