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|
Dovetailing Nicely With Diversification GoalsThe capital markets ETF could easily fit into a diversified portfolio as part of the financial sector allocation. After the most recent run-up in the group, financials now comprise 21% of the S&P 500 index, so an investor wanting to maintain an equal weighting vs. the S&P 500 without much single-stock risk might have 18% in a broad-based financial ETF like Financial Select Sector SPDR ( XLF) and 3% in KCE. That might not seem like much exposure on its face, but with 13.6% of XLF invested in capital markets stocks, the overlap is actually 5.4% to this higher-octane part of the sector. Also, the financial sector is a good place to add foreign exposure in both developed and emerging markets. For instance, an investor can put 16% in XLF, 3% in KCE and the remaining 2% in something like iShares Singapore ( EWS), which has a 35% weight in the bank sector and a 3.6% yield, or a common stock like Banco de Chile ( BCH), which has a 6% yield, and would give exposure to a relatively stable Latin American economy. Either combination gives broad diversification within the sector, a chance to outperform the sector and not much in the way of single-stock risk.
Subsectors Carry RisksAs mentioned earlier, financials have a 21% weight in the S&P 500, and it has been around 20% for a while. Historically, growth beyond 20% has led to nasty declines. For example, technology in 2000 and energy in the early 1980s each grew to about 30% of the index, prior to disastrous drops. Flat yield curves make lending money less profitable. The yield curve has been getting flatter and if inverted would make lending a losing proposition. This creates an obvious headwind for the banks.
|Banks Beat Brokers on Flat Curve |
|Source: Roger Nusbaum|