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Capital Markets ETF Offers Diversity

State Street has three interesting financial sector ETFs that are now listed and trading. The three new funds are the streetTRACKS KBW Bank (KBE), streetTRACKS KBW Capital Markets (KCE) and streetTRACKS KBW Insurance ETF (KIE).

ETF companies have created a lot of "me too" products lately, but these ETFs may have some promise, and I am especially interested in the Capital Markets ETF (KCE).

In general, investing in brokerage stocks, public exchanges and asset managers can be a way to add extra return in the financial sector. Simply put, bull markets and expanding economies may be most evident in this part of the market.

Take a look at Chicago Mercantile (CME) or Archipelago Holdings (AX) for some evidence.

Brokers In a Bull Market
Source: Roger Nusbaum

Until the KCE came along, the capital markets portion of the financial sector had been very under-represented in the wave of new investment products over the last couple of years. The largest stocks in this subsector, like Merrill Lynch (MER) or Morgan Stanley (MWD), don't have enough weight in the broad financial sector ETFs to allow investors to capture the effect.

KCE isolates this area nicely. The fund's breakdown is 41.53% full-service brokerage, 22.12% asset managers, 16.02% back-office processing, 12.09% discount brokerage, and 8.22% publicly traded exchanges.

Digging further into the nuts and bolts, you might expect some very large holdings in the fund, and there are. Goldman Sachs (GS) makes up 10%, Merrill Lynch 9.5% and Morgan Stanley 8.5%. This shouldn't be too surprising, because narrow subsector ETFs are likely to always be heavily concentrated in a few holdings.

KCE will not have much, if any, yield. I plugged its holdings into Morningstar's software and saw that the portfolio might yield 1.09%, but the expense ratio of the fund is 35 basis points, leaving 74 basis points. That is my calculation, and State Street has not announced a dividend.

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