Why Further Gains Are Likely For The Financial Select Sector SPDR Fund ETF (XLF)

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August 8, 2013 4:09pm NYSE:UYG NYSE:XLF

bankOf late, the financial sector has gathered strength and has been a leading light in the ETF industry. A steeper yield curve and the shift towards cyclical sectors from the defensive ones were the main reasons behind this move higher, but the sector also

has relatively modest valuations that are attracting investments.

The recent uptrend in long-term interest rates after so much of the ‘Taper’ related talks helped the operating backdrop for the sector quite a bit as it is leading to a steeper yield curve which benefits the banks.

Earnings estimate revisions for the sector have also been quite bullish given the neutral revisions trend for the S&P 500 as a whole. Meanwhile, financials have accounted for the largest increase in dividends in the last three years (Read: 2 Sector ETFs Surging This Earnings Season).

Given this bullish trend, a look at some of the top ranked ETFs in the space could be a good way to target the best of the segment with lower levels of risk. In order to do this, investors can look at the Zacks ETF Rank and find the top financial funds via this route.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class. Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

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

For investors seeking to apply this methodology to their portfolio in the Capital Market sector, we have taken a closer look at the top ranked XLF. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below.

About XLF

Launched in Dec 1998, Financial Select Sector SPDR Fund ETF (NYSEARCA:XLF) is a passively managed exchange traded fund (ETF) designed to track the performance of the Financial Select Sector Index.

The fund has now amassed as much as $17.1 billion and trades in volumes of 51 million shares a day on an average. This strong data helped the fund retain the status of the most popular and liquid ETF in the space. The fund charges an expenses ratio of 18 bps which is lowest in the space.

The ETF has come out as the best performing product in the financial ETF world in fiscal 2012 and has continued with its impressive rally even into 2013. This fund from State Street holds about 81 financial securities, weighted by market capitalization for the exposure.

Top companies include the usual suspects of Wells Fargo, Berkshire Hathaway and JP Morgan, all of which account for more than 8% of the assets. All these companies posted solid earnings in the most recent quarter.

The concentration level in the top 10 holdings is 51.2%. In terms of an industry breakdown, insurance takes the top spot at about 26% of assets, followed by broad financial services (24.5%) and then banks (17.6%).

Meanwhile, investors should note that the fund is skewed heavily towards large cap securities, thus lowering the risk quotient of the fund since large cap funds are less volatile. As such, we have a ‘Low’ risk outlook for XLF in the near term, however, this definitely does not mean low returns for the ETF (Read: Top Three High Yield Financial ETFs).

The fund has returned about 23.4% so far this year. XLF pays out a yield of 1.50% per annum. Over the last one-year period, the return from XLF (41.8%) outperformed the S&P/TSX Capped Financial Index (20.3%) as well as the S&P 500 Index (22.1%). Leveraging this bullish trend of the financial sector, XLF drew 21.3 million shares in the week ended July 22, 2013 as the top gainer amongst ETFs.

Bottom Line

XLF could be a winner thanks to its high exposure to insurance sector which has been rebounding nicely on the back of rising premium rates. The recent upsurge in health and multi-line as well as life and property/casualty insurance are favoring the broader insurance sector. Further, a stronger overall business climate will likely lead to a rally in the financial sector, thus making XLF a solid choice for investors across the board.

This article is brought to you courtesy of Eric Dutram.

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