Credit: Shutterstock photoF inancial ETFs often rake in the dough in a rising rate environment. So this quarter, higher odds of an interest-rate hike have boosted banking and insurance stocks.
Both Financial Services Select Sector SPDR ( XLFS ) andFinancial Select Sector SPDR ( XLF ) topped their nine Sector SPDR ETF peers in November.
XLF, with $16.5 billion in assets, is recovering from a Q3 slump. It rose nearly 2% last month and saw $603 million in net inflow.
Some six years after the financial crisis, the economic recovery seems to be on a permanent footing, says Chuck Self, CIO of iSectors, an ETF strategist firm that manages roughly $175 million in assets.
"Financial companies are seeing a rebound in demand as consumers' balance sheets are being repaired and demand for business investment has increased," he added.
In other words, consumers are willing to spend on new cars and homes. Businesses are looking to grow. Those activities are keeping banks and insurers busy.
And financial ETFs are busily finding their way into investors' ETF strategies .
Self considers the damage from post-crisis regulatory and legal issues "well priced into the price of these stocks."
The financial sector also stands to benefit further from the first Federal Reserve rate hike in almost a decade.
Such a move would pad net interest margins for banks, insurers, brokerages and money managers.
On the flip side, financial ETFs can be volatile.
Their economically sensitive holdings could take a hit if unemployment rises or consumer confidence dips.
Overweighting Financials
At iSectors, money managers have had a steady overweight to the financial sector vs. the broad S&P 500 index this year.
The firm usesiShares U.S. Financials ( IYF ) in its managed portfolio strategies.
The $1.65 billion ETF is up 1.9% year to date through Dec. 2 vs. 0.5% for XLF.
The two ETFs' three- and five-year annualized average performance are neck and neck.
IYF is relatively low cost, sees very tight trading and has tremendous liquidity, Self said.
He also likes the ETF's market-cap range. It holds large, midsize and small companies, unlike some peers focused on large caps.
IYF holds 288 stocks, with the biggest stakes inWells Fargo ( WFC ),Berkshire Hathaway (BRKB) andJPMorgan Chase ( JPM ).
Income Investing
Self's firm also hasMarket Vectors BDC Income (BIZD) on its watch list.
The ETF surged 8% last month and is up 2% year to date.
It invests in business development companies (BDCs) that provide debt financing to micro companies to help them grow.
The BDC business has grown very significantly in the past few years, according to Self.
Regional banks generally consider companies with under $100 million in market capitalization as too small to lend to. Credit unions and community banks consider them too big to lend to.
"That's where BDCs have come in," Self said. "They're filling an important part in lending to small businesses in the marketplace."
The majority of lending by BDCs is tied to floating rates.
"We think they are a very attractive vehicle for investors as rates go up," Self said.
BDCs would fit best in the liquid alternative sleeve of a portfolio for investment success , he added.
A relatively new ETF, BIZD's assets are a meager $85 million and average daily trading volume is just 39,000 shares.
However, for investors hunting for income, it offers an 8.49% yield.
It has an equally eye-popping expense ratio -- 9.45%.
That largely reflects the costs to access the underlying BDCs, Self said. The fund itself charges 41 basis points.
Both XLF and BIZD fell on the stock market today amid broad losses.
Follow Aparna Narayanan on Twitter @IBD_ANarayanan .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
