Top Ranked Financial ETF: First Trust Financials AlphaDEX ETF (FXO, XLF, XLY, WFC, C, USB, JPM)

Eric Dutram: As the third quarter earnings season takes shape, the financial sector has established itself as a winner. So far, big names like J.P Morgan (NYSE:JPM), Wells Fargo & Co (NYSE:WFC), Citigroup (NYSE:C) and U.S Bancorp (NYSE:USB) have all reported positive growth in earnings while also beating consensus estimates as well.

This strength comes despite the sluggish economic environment which has led to deceleration in overall credit growth, as many companies have been able to increase their top line revenue which has resulted in positive margins for them. However, net interest margins have significantly been under pressure especially for big asset sensitive banks mainly thanks to the low interest rates in the economy.

Also, subdued net interest income couple with high provisioning could lead to margin pressures in the upcoming quarters as well. However, non fund based fee income along with strong capital positions are the key positives for the sector going forward (readCommodity ETFs in Focus as Fed Unleashes QE3).

From a stock market performance perspective, the financial sector has been leading the market rally in the S&P 500 so far this year. In fact, the Financial Select Sector SPDR (NYSEARCA:XLF), which tracks the performance of all financial sector companies from the S&P 500, has been leading and the market and is up by almost 23% YTD at the time of writing, comfortably ahead of Consumer Discretionary (NYSEARCA:XLY) which has added about 18.8%.

Given this, a look at the Zacks #1 Ranked financial ETF could be a winning choice for investors especially if the positive trend in earnings for the sector continues through the present earnings season.

About the Zacks ETF Rank

A look at top ranked Financial ETFs can be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.

Using this strategy, we have found one ETF which is Ranked 1 or ‘Strong Buy’ with this model in the financial sector which we have highlighted in greater detail below:

First Trust Financials AlphaDEX ETF (NYSEARCA:FXO)

Launched in May of 2007, the ETF tracks the StrataQuant Financials Index which employs an AlphaDEX stock selection methodology from the Russell 1000 index with a core focus on financial stocks. The AlphaDEX methodology of stock selection takes into account various growth as well as value factors in order to filter stocks from the broad index.

Of course there are various other filters within this strategy to arrive at a final portfolio of stocks which makes the underlying index. Nevertheless, thanks to this innovative fund management technique, FXO charges a hefty expense ratio of 70 basis points.

Presently the ETF has a portfolio of 164 stocks. FXO does well in eliminating concentration risk as it does not allocate much in any single component. In fact, Citigroup is its highest weighted stock with just 1.16% allocation. Some of the other stocks in its portfolio are AIG Inc, (1.13%), MBIA Inc, (1.11%) and Assurant Inc, (1.11%) (read Financial ETFs in Focus as Pandit Quits Citigroup).

FXO has had an excellent run this year and is up by 16.17%. However, from a one year look, it seems to have fared even better. The ETF has returned 31.38% on a one year basis as of 30thSeptember 2012.

FXO currently has an asset base of $187.46 million and on an average does a daily volume of about 259,000 shares. It also pays out a paltry yield of 1.32% (see more in the Zacks ETF Center).

From a risk perspective, the ETF can be considered relatively less risky, especially compared to its other financial counterparts. FXO has a three year annualized standard deviation of just 22.69%. This is reflected in our ‘Low’ risk outlook for the ETF along with a Zacks ETF Rank of 1 or ‘Strong Buy’ over the next 12 months.

Written By Eric Dutram From Zacks Investment Research  

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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