financial etf

How to Pick a Financial ETF

How do you pick a financial ETF?

With the financial sector heating up, investors who want exposure to this sector have a choice of either researching stocks, or buying a broad-based ETF. There will be winners and losers in the financial sector, and if you invest the time, and stay on top of the news, individual stock selection may be the best way to jump into the financial sector. However, if you simply don’t have the time, knowledge, and resources to sift through stocks for the winners or if you want  broad exposure to multiple companies in the sector, let’s take a look at the financial ETFs that you have available to you.

First, the sector in general is going through a renaissance after struggling through many years of recovery from the housing and mortgage crisis. That crisis caused interest rates to plummet and the government to impose new regulations on the banks. Both of those are bad for business, and banks were already struggling to rebuild their balance sheets from the crisis. Now the balance sheets have been rebuilt (see Fed Stress test results), and short term interest rates are creeping up and regulation is waning under the new administration. All of this adds up to a great environment for banks.

The flagship ETF in the financial sector is the S&P Financial Select SPDR. It is designed to mimic the S&P 500’s financial sector. It has over $25 billion in assets, which means that you will easily be able to trade in and out of this holding. Additionally, it sports a very low expense ratio of .14, which means that the management of this financial ETF does not incur many expenses that would come out of your pocket. On the surface, this looks like a good choice.

But let’s look a little deeper. The XLF is very concentrated. In fact, almost 50% of their holdings are in a narrow band of 7 holdings. These are the largest banks (Wells Fargo, JP Morgan, Bank of America, etc.). So, while there is some diversity, it does not give you exposure to some of the regional powerhouses. If this matches your investment perspective, then stop reading right here. But what else is out there?

In Chaikin Analytics, I sorted the financial sector ETF’s by six month performance, and got an impressive list.

KCE is an interesting performer, up almost 10% over the last six months. This financial ETF is a little more expensive, shows better diversification (largest holding is 2.3%), but does not trade a great deal (it is a smaller ETF – with just over $100 million in assets), and it has a higher expense ratio of .34.

RYF is an equal-weighted version of XLF.  It, too, has had excellent performance, and by equal-weighting the basket of stocks, you don’t end up putting large bets on the biggest stocks. So if you want to bet on the biggest and strongest stocks, a market cap weighted financial ETF like XLF is a good choice. If you don’t want those big bets, then an equal-weighted ETF is a better choice.

The last one that we will talk about is the KRE – the SPDR for regional banks. While this ETF (up 3.5% over the past 6 months) hasn’t performed as well as ETFs that focus on the big names, it’s focus on the regional players gives it a different holding set that could be intriguing. It has a low expense ratio, and it is large enough to trade easily.

There are so many ways to get financial sector exposure. None of these ETFs are overly expensive, they all have plenty of liquidity, but each has a slightly different flavor. Understanding these differences should help choose the right financial ETF for your portfolio.