Financial ETFs for Playing M&A Wave

By Michael Johnston, founder of ETF Database

Over the past few weeks, there has been a resurgence in acquisition activity, fueling an already strong market rally. This news has spanned all regions of the economy ranging from the transportation sector (Burlington Northern(BNI Quote) being taken over by Berkshire Hathaway(BRKA Quote)) to pharmaceuticals (Schering Plough (SGP Quote) being acquired by Merck(MRK Quote)).

Most recently, in the consumer sector, Kraft(KFT Quote) announced its intention to take over confectionery giant Cadbury while Hewlett-Packard (HPQ Quote)announced plans to buy 3Com(COMS Quote).

While the deals almost always push up the stock price of the company being acquired, the M&A activity is a welcome development for the investment banking industry, which is still suffering from the hangover of the financial crisis of 2008 and 2008.

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Investment banks have received nearly $4 billion in revenue from these transactions in 2009, and should this consolidation trend continue, it could be very good news for the entire financial sector.

While most financial ETFs have a weighting toward investment banks, some have a much bigger allocation than others.

The four ETFs highlighted below have a significant weighting toward the major investment banks that could benefit from an uptick in M&A activity, including Goldman Sachs(GS Quote), JPMorgan Chase(JPM Quote), Morgan Stanley(MS Quote), Citigroup(C Quote), and Bank of America(BAC Quote)/Merrill Lynch, which take up the top five spots in the M&A financial advisory category.

• SPDR Select Financial Sector Fund(XLF Quote): This ETF has a dividend yield of 2.7% and holdings in 79 different companies. The focus of this fund is giant and large-cap firms, which make up more than 80% of the holdings, giving XLF an average market cap of $36 billion.
• Vanguard Financials ETF(VFH Quote): Vanguard's financial ETF also has a strong weighting toward large caps, but also invests nearly one quarter of total assets in mid-cap securities. This ETF offers the most depth of holdings, with more than 500 individual securities. VFH pays a dividend of 2.5% and maintains a low expense ratio of just 25 basis points.
• iShares Dow Jones U.S. Financial Sector(IYF Quote): This ETF is also spread out among large and mid caps, and it has over 250 securities in the portfolio, although 43% of the fund is in the top 10 holdings.
• iShares Dow Jones U.S. Financial Services(IYG Quote): Despite this ETF's large number of holdings (over 100) almost two thirds of the fund is in its top ten holdings, including JP Morgan, Bank of America, and Wells Fargo. The fund pays a modest dividend yield and is skewed large caps, which comprise nearly 60% of the fund.

Comparison

As presented in the chart above, there are a few small differences between the holdings of these ETFs and their allocations to each of the major investment banks. IYG holds nearly three times as much in Citi as VFH does, and IYG maintains a larger weighting in both Bank of America and JPMorgan as well.

In fact, IYG holds the highest percentage in four of the five banks, with only its weighting in Goldman Sachs being edged out by the weighting in XLF. Meanwhile, VFH is the most diversified with the smallest holdings in four of the five banks with once again Goldman being the outlier.