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Investors Are Cutting Back on Financial ETF Exposure

This article was originally published on ETFTrends.com.

Financial sector-related ETFs have been slowly going out of favor as some investors grow concerned over the outlook for bank earnings.

For example, the Financial Select Sector SPDR (XLF) has experienced $928.8 million in outflows since the start of the second quarter.

The average U.S.-based fund has diminished its stake to financial companies by almost 1.1 percentage points in the second quarter to approximately 14%, the largest single-quarter reduction since at least 2013, Reuters reported.

U.S. rate hikes

Fund managers argued that banks have already hit peak earnings, pointing to some red flags such as the U.S. Treasury curve flattening as short-term yields rise in response to U.S. rate hikes from the Federal Reserve and long-term yields dip on growth and trade concerns. The flatter yield curve would typically diminish bank profits as they try to profit on the spread - short-term rates affect a bank's borrowing costs and long-term rates limit how much they can charge on loans.

“The flatter the yield curve the harder it is to make money,” Ian McDonald, co-leader of the financials research team at Janus Henderson Investors, told Reuters, adding that “funds are looking around and saying that if we’re going to see weaker growth then we need to get out of financials.”

The spread between yields of two-year and 10-year U.S. Treasuries are now their flattest in 11 years.

Related: Thematic ETFs to Enhance Your Investment Portfolio

Banks may have stronger balance sheets than during the start of the financial crisis a decade ago, but “we’re having a hard time finding anything to get excited about in financials,” Tom Plumb, manager of the Plumb Equity Fund, told Reuters.

Nevertheless, there ongoing innovation may continue to support larger banks. McDonald argued that large-cap banks remain attractive as they have been investing in online platforms and mobile apps, which make the companies more appealing to young millennials and less dependent on more costly physical branches.

“The U.S. retail banking industry is moving from the post-crisis phase of risk management to the fintech phase of managing customer experience,” McDonald said.

For more information on the banking sector, visit our financial category.