A Look at 2013’s Best Financial Services ETF

ETF Trends

Just two years removed from being one of the worst-performing sectors, financial services has made an impressive resurgence in 2013.

Yet even with gains of 33.2% for the Financial Select Sector SPDR (XLF) and 43.8% for the SPDR S&P Regional Banking ETF (KRE) , and that is just to name stellar performers in an ETF patch littered with them, low valuations indicate financials may not be getting the respect they deserve. [Financials are Getting no Respect]

The iShares U.S. Broker-Dealers ETF (IAI) is a prime example of a financial services ETF that deserves some respect. A 2013 gain of 62.4% says as much. Some investors have given IAI its due. The ETF had $209.1 million in assets under management as of Dec. 19, nearly double its total on June 10. [Broker-Dealers ETFs Soar]

IAI has been bolstered on multiple fronts. Home to discount brokers such as Charles Schwab (SCHW), TD Ameritrade (AMTD) and E-Trade Financial (NasdaqGM:EFTC), IAI has benefited as more individual investors join the rally in U.S. stocks.

Broker-dealers, another significant chunk of IAI, as its name implies, are better suited to withstand rising interest rates than other financial picks. Ten-year Treasury yields are up 59% this year, indicating IAI has move in near lockstep with benchmark bond yields. In fact, IAI was highlighted by Credit Suisse earlier this year as one of the bank’s top picks for a rising rate environment.

IAI is home to just 22 stocks, just a fraction of the 267 found in the iShares U.S. Financials ETF (IYF) and the narrower portfolio does lead to increased volatility. IAI’s three-year standard deviation to 22.17% is nearly 500 basis points higher than IYF’s, according to iShares data.

Even with the run up in the financial services sector this year, the group is not expensive. Actually, the opposite is true. The sector trades at 12.7 times forward earnings, the lowest of the 10 S&P 500 sectors. New Dow component Goldman Sachs (GS), IAI’s second-largest holding, trades at 12.1 times next 12 months’ earnings-per-share estimate.

Morgan Stanley (MS), IAI’s third-largest holding, has reported four consecutive quarters of higher earnings and revenue. Goldman and Morgan Stanley combine for 14.2% of IAI’s weight.

The outlook for IAI’s bulge bracket/investment banking components heading into 2014 is bright. Corporate leaders expect “a 17 percent rise in M&A activity. Bond and syndicated loan activity is also expected to rise 17 percent. Sixty-one percent of the hochos think there will be growth funded by public share offerings,” according to CNBC.

iShares U.S. Broker-Dealers ETF

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IAI

 

Tom Lydon’s clients own shares of KRE

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