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3 Overlooked Financial ETFs Beating the Market

Sweta Killa

Financial stocks, which were lagging this year, have suddenly caught investors’ attention led by a surge in banking stocks and improving economic fundamentals.

As per SNL Financial, U.S. banks are lending at the fastest pace since the financial crisis. This is especially true as banks delivered the second-highest profit of $40.24 billion in at least 23 years in the second quarter, just below the record of $40.36 billion in the first quarter of 2013 (read: Best Financial ETFs for This Market Slump).

Solid loan growth, steadily improving credit quality, litigation settlements, heightened M&A and IPO activities, as well as stable balance sheets are fueling optimism in the broad sector. Further, a healthy job market, growing manufacturing and service sectors, renewed housing recovery and rising consumer confidence would lead to higher demand for all types of financial services.

The strengthening economy picture and the expected end of Fed stimulus in October are raising speculations of an interest rate hike sooner than expected, although the Fed is expected to keep interest rates at a low level till mid 2015. A rising interest rate scenario will likely benefit financial companies, including banks, insurance and e-brokers.

Financial stocks are also benefiting from their ability to increase dividends and buybacks, which often act as a safety in turbulence times. The financial sector topped the list of largest dividend payers in the second quarter after utilities with annual dividend growth of 17.6%. About 88.5% of the companies in the financial sector paid dividends in the first half (read: 3 Unbeatable Dividend ETF All-Stars for Your Portfolio).

Moreover, these stocks appear relatively undervalued when compared to the other U.S. equities, making them attractive at present. Notably, the S&P Financial Select Sector SPDR Fund (XLF) has a P/E ratio of 15.04 and P/B ratio of 1.35 while the broad U.S. market fund (SPY) has a P/E ratio of 16.72 and P/B ratio of 2.67.

Given bullish fundamentals, many financial ETFs have impressed with their outstanding performances of late. Interestingly, these top performers are spread out among various financial segments. Below, we have highlighted three ETFs that have easily crushed the broad market funds over the past 10 days but have often been overlooked by investors.

PowerShares KBW Capital Markets Portfolio ETF (KBWC)

This ETF follows KBW Capital Markets Index, which measures the performance of the companies that do business as broker dealers, asset managers, trust and custody banks or exchanges. It has amassed about $5.1 million in its asset base while volume is very light under 2,000 shares, ensuring additional cost for this unpopular fund beyond the expense ratio of 0.35% (see: all the Financial ETFs here).

Holding 24 stocks in the basket, the product is largely concentrated on the top five firms, accounting for over 41% of total assets. Morgan Stanley (MS), BlackRock (BLK) and Schwab Charles (SCHW) are the top three holdings. The ETF has added about 4.1% in the period under consideration and has a Zacks ETF Rank of 4 or ‘Sell’ rating with a Medium risk outlook.

iShares U.S. Insurance ETF (IAK)

This fund provides exposure to the insurance segment of the broader U.S. financial sector by tracking the Dow Jones U.S. Select Insurance Index. The product holds 67 stocks in its basket with double-digit allocation going to American International (AIG) and MetLife (MET). These two companies collectively make up for 24.8% share in the basket. Other firms hold less than 7.3% of assets.

The product is rich in AUM with nearly $122.8 million and charges 43 bps in fees per year. Volume is light, trading in about 22,000 shares per day. The fund gained about 4% over the past 10 days and has a Zacks ETF Rank of 2 or ‘Buy’ with a Medium risk outlook (read: Top Ranked Insurance ETF in Focus: IAK).

Market Vectors Bank and Brokerage ETF (RKH)

This product offers exposure to the 26 largest U.S. financial services companies and follows the Market Vectors US Listed Bank and Brokerage 25 Index. It has managed $16.1 million in AUM and sees a paltry trading volume of about 1,000 shares a day. Expense ratio came in at 0.36%.

The fund is highly concentrated on the top 10 holdings at 63.5%, with Wells Fargo (WFC), J.P. Morgan (JPM) and HSBC Holdings (HSBC) taking the top three spots. RKH was up about 4% over the past 10 trading sessions and has a Zacks ETF Rank of 3 or ‘Hold’ with a High risk outlook.