Are financial services ETFs going to be a winning play in 2020?
CNBC recently asked several investment professionals to discuss the ETF themes that will drive gains in the year ahead. Among the six themes listed, bank stocks were at the front of the line.
John Davi, the chief investment officer of Astoria Portfolio Advisors, especially likes the big bank stocks. That’s because they “don’t have the leverage that they used to have,” Davi stated. He also likes them because they’re trading at 12-13 times earnings, making these stocks value plays in a market where cheap is hard to find.
Although it’s hard to fault the CIO’s logic, I’d like to think that a more diversified portfolio of financial services stocks is the safer way to play this winning theme in 2020.
For this reason, I’ve come up with a list of seven financial services ETFs to buy that have a minimum of 25% and a maximum of 60% of the ETF’s net assets invested in bank stocks.
May these recommendations put money into your bank account.
Financial Select Sector SPDR Fund
Total net assets: $26 billion
Management expense ratio: 0.13%
Financial Select Sector SPDR Fund (XLF) is the largest U.S.-listed financial services ETF in terms of total net assets. Banks account for 42.7% of those assets. The second- and third-largest subgroups are capital markets and insurance at 21.6% and 17.9%, respectively.
The ETF tracks the performance of the Financial Select Sector Index, which consists of all the financial services stocks in the S&P 500. In existence since December 1998, XLF currently has a total of 66 holdings with a median market capitalization of $24.6 billion.
The top three holdings are Berkshire Hathaway (BRK/B) with a weight of 12.93%, JPMorgan (JPM) at 12.41% and Bank of America (BAC) at 8.12%.
Except for Berkshire, American Express (AXP), Goldman Sachs (GS) and CME Group (CME), all of its top-10 holdings are big banks. That said, XLF gives you enough of a bank theme without missing out on some of the other great businesses making money from financial services.
Vanguard Financials ETF
Total net assets: $7.9 billion
Management expense ratio: 0.10%
Although the Vanguard Financials ETF (VFH) doesn’t have as much as XLF in the way of total net assets. However, the fact that it has an management expense ratio (MER) that’s three basis points lower does make it attractive.
VFH tracks the MSCI US Investable Market Index (IMI) Financials 25/50. That’s a mouthful, I’ll grant you, but it merely means that no group of stocks (E.g., bank stocks, etc.) can exceed 25% of the portfolio. Further, the individual stocks with a weighting exceeding 5% can’t add up to more than 50% of the portfolio. The 25/50 indexes are rebalanced four times a year in February, May, August and November.
Banks account for around 50% of the ETF’s total net assets. That said, its top-10 holdings are identical to XLF. The only difference is that VFH’s top-10 holdings represent 43.6% of the portfolio compared to 55% for XLF.
Another difference between the two ETFs is that XLF has just 66 holdings compared to 428 for VFH. Furthermore, VFH has a median market cap of $66.5 billion, almost three times XLF.
Lastly, it’s got a healthy 30-day SEC yield of around 2.2%.
First Trust Financials AlphaDEX Fund
Total net assets: $2 billion
Management expense ratio: 0.63%
As passive ETFs go, the First Trust Financials AlphaDEX Fund (FXO) isn’t cheap at 0.63% annually. However, what it loses in price attraction, it gains in performance. Over the past 10 years, its annualized total return is 12.1%.
While past success doesn’t guarantee future success, the ETFs methodology — it uses a combination of growth and value metrics to rank all the financial stocks from the Russell 1000 — providing investors with a nice blend of financial services companies.
Reconstituted and rebalanced quarterly, it is what I would describe as a passively active ETF — which should perform in good times and bad. Another exciting aspect of FXO is that it skews toward smaller stocks with a median market cap of just $9.9 billion, about one third the market cap of XLF.
Another interesting twist is that REITs account for nearly 14% of the ETF’s portfolio, providing investors with some real estate exposure at the same time.
However, if you favor the big bank stocks, FXO is probably not for you. Banks account for just 25.7% of its $2 billion in total net assets.
Invesco S&P 500 Equal Weight Financials ETF
Total net assets: $273.9 million
Management expense ratio: 0.40%
The Invesco S&P 500 Equal Weight Financials ETF (RYF) tracks the performance of the S&P 500 Equal Weight Financials Index, which tracks the same stocks as the XLF. However, unlike the cap-weighted ETF, RYF equal-weights all 66 of the S&P 500 stocks.
What’s the difference in performance?
Over the past 10 years, the RYF generated an annualized total return of 12.85%. This is 122 basis points higher than the XLF, despite an MER that’s three times more expensive.
A quick look at the ETF’s top-10 holdings reveals that only two are also part of XLF’s top-10 stocks. Further, the top-10 holdings, because it’s based on an equal-weight index that rebalances quarterly, account for just 16% of the portfolio.
In my experience, if you can put up with slightly more expensive MER’s, equal-weight ETFs are always the way to go.
Fidelity MSCI Financials Index ETF
Total net assets: $1.1 billion
Management expense ratio: 0.084%
I don’t know if you’ve noticed, but I’ve included seven different ETF providers in this article — opting for variety over the most popular such as iShares or Vanguard.
The Fidelity MSCI Financials Index ETF (FNCL) tracks the performance of the MSCI USA IMI Financials Index. Passively managed, it invests in 357 financial services stocks selected from the MSCI USA IMI Index — itself, a collection of 2,411 stocks covering approximately 99% of the free float-adjusted U.S. market cap.Collectively, the financials account for 14% of the MSCI USA IMI portfolio.
FNCL is most similar to VFH, which was mentioned previously. The only difference being that Fidelity’s ETF doesn’t have a 25/50 governor on its fund as Vanguard does. As a result, it has 71 fewer holdings than VFH.
As for performance, VFH’s five-year annualized total return of 11.16% is slightly lower than FNCL at 12.22%, but there’s very little to choose from when it comes to the two MSCI financial services indexes.
iShares Global Financials
Total net assets: $513.4 million
Management expense ratio: 0.46%
I usually don’t start a blurb about a stock or ETF I’m recommending by providing Morningstar’s quantitative rating. However, with just two stars, I thought it was important to mention the fact upfront.
As for the iShares Global Financials ETF (IXG), it tracks the performance of the S&P Global 1200 Financials Index, a subset of the S&P Global 1200. IXG has 189 holdings, with its top-10 accounting for about 30% of the ETFs total net assets.
Banks have a substantial presence in the ETF, with a weighting of 50.8%. From a geography perspective, U.S. stocks account for 48.7% of the portfolio, Canada is second at 7.5% and the UK is third with 6.7%.
Its performance over the past 10 years (6.6% annualized) is part of the reason it’s got just two stars from Morningstar. However, I don’t think there’s any doubt that it can do better in the years ahead.
If you want to cover financial services companies on a worldwide basis, I’d consider a 10-20% allocation for IXG with the remainder dedicated to a U.S. financial ETF.
VanEck Vectors BDC Income ETF
Total net assets: $247.9 million
Management expense ratio: 9.62%
I’ve chosen to include the VanEck Vectors BDC Income ETF (BIZD) in my seven recommendations despite the eye-popping MER of 9.62%. That’s because the annual fee is somewhat misleading, and furthermore, BIZD is an excellent way for investors to generate income.
First, BIZD’s MER is high because it takes the assets brought in and reinvests in business development companies (BDCs) who charge management fees for the funds they invest. These are called “Acquired Fund Fees” and are a cost of doing business in this segment of the market.
If you exclude these, the management fee is quite respectable, at 0.4%.
As for income generation, BIZD has a 30-day SEC yield of 8.73%, significantly higher than any of the other ETFs mentioned in this article. The yield is high because BDCs are required to give out at least 90% of their taxable income to shareholders as part of being treated as a regulated investment company, or RIC.
However, it’s important to note that many BDCs lend money to the lower- and middle-markets whose companies aren’t as financially stable as blue-chip companies such as Berkshire Hathaway.
You don’t get 9% yields without additional risk. And if you can handle above-average risk, it’s worth considering BIZD for a tiny sliver of your financial-services exposure.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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