You would expect financials to fail as bond yields fall.
Yet, the broad sector held up remarkably well this past week.
And according to our TrackstarIQ Data, searches from institutional advisors picked up accordingly.
With the Fed hinting at potential tapering later this year, bond prices could see a sharp decline in the coming months.
And that’s a big win for some financials.
You see, banks make their net interest income by borrowing on shorter duration bonds and lending at the higher duration rates.
Generally speaking, bond prices at the long end of the curve (10 years or more) drop more in percentage terms than 2-year bonds.
That creates a steepening yield curve, which describes the relationship between short-duration and long-duration yields.
So, if we think the Fed will cut back on treasury buying, chances are the price of those bonds will fall, causing yields to rise and banks profitability to improve.
For those of you looking to take advantage of this potential trend here are some ETFs worth considering.
Financial Select Sector SPDR Fund XLF
One of the most popular searches lately, and by trading volume, the XLF is a broad-based financial ETF that creates a nice balance of financial companies.
While it owns 66 stocks, the top 10 represent more than half of the index. However, only two are more than 10%.
With high popularity and ample liquidity, the ETF trades with low spreads, a solid 0.12% expense ratio, and pays a dividend yield of 1.61% annually.
Vanguard Financials ETF VFH
If you want a more diverse basket of equities, Vanguard’s VFH is your go-to product.
With an even lower expense ratio of 0.10%, VFH holds a whopping 424 companies with no single one at more than 10% of the total holdings and the top 10 accounting for 42.4% of the portfolio.
Does that help it do better?
Well, year to date, it’s returned 23.13% compared to the XLFs 23.04%.
With more holdings, you stand less of a chance any one company’s performance has an outsized impact on your portfolio.
SPDR S&P Regional Banking ETF KRE
Smaller, regional banks tend to outperform larger institutions during upswings.
The KRE ETF focuses entirely on regional banks within the U.S.
To give you an idea of how much better they do, the KRE is up 28.04% year-to-date compared to the ~23% for the other two financial ETFs we discussed.
Regional banks benefit not just from better interest rate margins, but increased economic activity – something in vogue at the moment.
The expense ratio is a bit higher at 0.35%. But with 134 holdings and a nice 2.15% dividend yield, it’s a great choice if you want to get more exposure to the bond story.
Our hot take
When in doubt, opt for more diversification and higher dividends. These provide protection during heavy drawdowns.
Questions from your clients
- Where do payment processors like Visa and Mastercard fall?
- Is there a way to invest in online financial service companies?
- Are there ETFs or funds that invest in fintech?
- Do banks carry the same risks as before 2008?