Structure Matters With Bank ETFs
Seasoned exchange traded funds (ETFs) know that what's inside an ETF matters. And what's inside an ETF and how those holdings are weighted has a lot to do with a fund's underlying index. So just because two ETFs track the same industries or sectors, different underlying indexes lead to different outcomes for investors.
Bank funds are prime examples of funds with similar names with varying outcomes. Take the cases of the Invesco KBW Bank ETF (KBWB), which tracks the widely followed KBW Nasdaq Bank Index (BKX); and the Invesco KBW Regional Banking ETF (KBWR), which follows the KBW Nasdaq Regional Banking Index (KRX).
Two of the most direct competitors to those indexes are the S&P Banks Select Industry Index (SPSIBK) and the S&P Regional Banks Select Industry Index (SPSIRBK). Those are both equal-weight benchmarks and while there can be advantages to alternative weighting methodologies, data suggest the indexes KBWB and KBWR follow offer their own benefits over SPSIBK and SPSIRBK.
Over the past three years, the modified cap-weighted KBWB is up 58.20 percent compared with a gain of 51.30 percent by the ETF that follows SPSIBK. KBWB was also slightly less volatile than the SPSIBK tracking ETF over that period. As the chart below confirms, there are significant differences between BKX, KRX and rival bank benchmarks.
Courtesy: Keefe, Bruyette & Woods, Inc.
When buying a large-cap bank ETF, such as KBWB, investors are likely expecting to attain allocations to the major money center banks, such as Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM), among others. Conversely, when investors buy a regional bank ETF, such as KBWR, they either liking for an alternative or complement to a large- and mega-cap money center bank exposure.
Said another way, there should not be significant overlap between bank and regional bank indexes, but sometimes there is.
“Investors making a differentiated call on universal/large-regional versus pure regional banks would have benefited from the differentiated performance of the BKX and KRX as evidenced by their greater average quarterly spread over the past 31 quarters,” said Keefe, Bruyette and Woods (KBW) analyst Melissa Roberts in a research note out Monday.
Roberts notes the quarterly spread between BKX and KRX is 2.8x that of the aforementioned S&P bank indexes.
“The fact that 89% of SPSIRBK’s weighting comes from SPSIBK is a major driver of this undifferentiated performance,” said Roberts.
Industry funds, including KBWB and the regional bank-focused KBWR, are often favorites of tactical traders during earnings season, but for some sophisticated, earnings-driven strategies to work, there needs to be differentiation between the assets. The most recently completed earnings season confirmed BKX and KRX offered that differentiation in superior fashion to rival benchmarks.
“The lack of performance differentiation between SPSIBK and SPSIRBK was also evidenced in 1Q19 earnings reporting season,” said KBW's Roberts. “For investors trying to differentiate between the banks during first-quarter earnings reporting season, the BKX and KRX did a better job at conveying the unique performance between the large and regional banks. The spread between SPSIBK and SPSIRBK was a mere 0.2% from April 11 through April 30 while the spread between BKX and KRX was 1.3%.”
There is also wider price-to-earnings ratio gap between BKX and KRX than there is between SPSIBK and SPSIRBK.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.