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|