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Financials Could Drive Russell 2000 Out-Performance


U.S. small-caps are easily outpacing their large-cap peers this year as highlighted by the 4.4% gain by the iShares Russell 2000 ETF (IWM) . IWM’s year-to-date returns are more than double those offered by the S&P 500.

Investors speculating on continued out-performance by IWM should look at small-cap financial services names, IWM’s largest sector weight at 23.7%. Financials are in fact an important driver of IWM’s returns. The ETF’s next largest sector allocation is 14.6% to technology, according to iShares data.

Keefe, Bruyette & Woods recently evaluated some of the bank stocks in the Russell 2000, selecting 20 to overweight with a preference for higher beta names that are seen as prodigious loan growers and/or attractive acquirers of rival banks, said KBW in a research note.

Investors should remember that while IWM is heavy on financial services names, that group also includes business development companies and REITs along with banks. Additionally, no stock accounts for more than 0.38% of the ETF’s weight, which mutes the impact the banks highlighted by KBW can have on IWM. [Following ETF Money]

Seven of KBW’s top-20 ideas can be accessed via the PowerShares KBW Regional Banking Portfolio (KBWR) . That group includes SIVB Financial (SIVB) and Signature Bank New York (SBNY), KBWR’s largest an fifth-largest holdings, respectively.

That further enhances the allure of KBWR, which was recently highlighted as a solid ETF idea for investors looking to gain exposure to thriving California-based mid-cap banks. Overall, the seven KBW picks that appear in KBWR’s lineup combine for roughly 17% of the ETF’s weight. [An ETF to Bet on California Banks]

Though at smaller weights, SIVB and Signature are the top two holdings in the SPDR S&P Regional Banking ETF (KRE) . Like KBWR, KRE features seven of KBW’s top 20 ideas among its holdings. As an equal weight ETF, KRE is not highly exposed to any of its 81 holdings, but the names recommended by KBW do combine for nearly 11% of the ETF’s weight. [Stress Tests and Bank ETFs]

As has been noted regarding ETFs such as KRE and KBWB in the past, these funds make for ideal plays in rising interest rate environments. KBW confirms as much.

“In general, we do believe that higher rates is better for the bank group and will translate into higher NIMs and profits — and that the very high capital levels well cushion the risk of reduced bond values at the lion’s share of the banks,” said the research firm.

PowerShares KBW Regional Banking Portfolio

Tom Lydon’s clients own shares of IWM and KRE.