Why The Future Is Bright For This Financial Sector ETF

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July 15, 2013 4:40pm NYSE:KBWC

financial banksAfter seeing a rough patch for quite some time, the financial sector, especially the broker-dealer/capital markets segment of the industry, breathed a sigh of relief last year. Being one of the best performing segments in 2012, the sentiment for

the sector as a whole remains bullish in 2013 as well.

The recent rally in the equity market was mostly attributable to the performance of the financial stocks. The sector also has relatively modest valuations that are attracting investments.

Banks have bounced back following a series of hedging losses and scandals, surging almost 200% over the last four years. This strong performance was attributable to sound balance sheets, an uptick in mortgage activity, and lower loss provisions. Admittedly, a lot remains to be done in order to reach the levels seen before the global financial crisis, though many appear on their way to these marks.

Now, with an improving employment level, housing recovery, increase in consumer confidence and the Fed President’s recent dovish comments regarding easing, there is a general mood of optimism among investors.

Accordingly, we expect the capital markets segment of the sector to benefit from these positive developments. Strong earnings from several capital market companies, of late, also drove the segment’s performance (Read: 3 Surging Financial ETFs Beating the Market).

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 Capital Markets ETF.

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 KBWC. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ and is detailed below:

About KBWC

Launched in November 2011, the PowerShares KBW Capital Markets Portfolio ETF (NYSEARCA:KBWC) – a passively managed fund – provides investors with exposure to the capital market sector of the broad financial segment by tracking the KBW Capital Markets Index. It has amassed about $8.2 million in AUM while volume is very light, perhaps increasing the total cost for this unpopular fund.

Holding 25 stocks in its basket, the product puts more than 60% of its total assets in the top 10 holdings, suggesting a moderate concentration risk. State Street Corp. (STT), Morgan Stanley (MS) and Goldman Sachs Group Inc. (GS) take the top three spots in the basket with a combined share of 26.03%.

This choice is moderately expensive in the financial ETF space, with 35 bps in annual fees, as many of its counterparts charge even higher. Capitalization-wise, the fund is most exposed to large cap securities with around 65% allocation followed by mid (25%) and small cap (10%) securities. From a style look, the fund is also made up of a large chunk of value stocks (63%).

Its excessive focus on giant as well as value-oriented companies calls for low volatility. As such, we have a ‘Low’ risk outlook for KBWC in the near term. However, this definitely does not mean low returns for the ETF (Read: Top Three High Yield Financial ETFs).

Showing early signs recovery in the latter part of 2012, KBWC started to perform better and has been climbing in 2013, returning more than 40.0% in the one-year period ending June 30, 2013 and about 25.2% so far this year. Over the last one-year period, the return from KBWC outperformed the S&P/TSX Capped financial index (13.7%) as well as the S&P 500 ETF (20.6%).

The product also pays an annual dividend yield of 1.89%. KBWC hit a low of $28.64 and a high of $42.94 in the last one year, though the fund is currently hovering modestly below its 52-week high price.

Bottom Line

The fund’s top 25% weight remains well-positioned with respect to its fundamental business activities, which include servicing, trading and securities finance, due to its significant global exposure and business diversification. All three companies State Street, Morgan Stanley and Goldman Sachs, reported sound earnings last season, and could be well-positioned this time around as well.

Additionally, at a time of increased market volatility, many of the exchanges in the ETF—like ICE, NYSE or CME, could stand to benefit from more financial market activity. Given this, there is reason to be bullish all around for this ETF, suggesting that both the near term future and the long term path could be very bright for investors in KBWC.

This article is brought to you courtesy of Eric Dutram.

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