Watch Your Megabank Weight

by on March 6, 2013 | ETFs Mentioned:

As the economy continues to show positive signs of recovery, investors are becoming bolder with their funds, even returning to an industry that many blame for the situation we are in now. Big or small, not all banks were able to weather the liquidity stress tests the last five years have put them through, but all are looking forward to the return of an expanding global market. With over 40 ETFs focusing on the financial sector, there are a number niche and broad prospective investors can take on in this massive global industry [see Visual History Of The S&P 500].

As financial institutions continue to evolve to meet their changing environment and clients, they can prove to be a strong holding, especially smaller financial firms that are booming in the market recovery. But be careful when choosing a fund; not all of them showcase such an even or growing sector of the financial industry.

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Many of the funds in the Financial Equities ETFdb Category seek to provide broad-based exposure to the entire financial industry market, including insurance, commercial banks, capital markets and REITs. Though the portfolios of the most popular financial ETFs vary in size and scope, there is one commonality found among almost all of these “mega” funds: big bank–more specifically, JP Morgan (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C). Allocations to these four heavy hitters range from as little as 1% to a whopping 40% of a portfolio’s total assets, meaning that the performance of these ETFs is highly dependent on only four stocks. Though significant tilts towards these mega banks have certainly not harmed ETFs in most recent years, any signs of trouble could have serious impacts on bottom line returns [see 10 Questions About ETFs You've Been Too Afraid To Ask].

The chart below highlights a number of the most-traded financial sector ETFs, revealing the differences between the historical performances, portfolio size and their weightings in mega banks:

  • Financial Select Sector SPDR (XLF, A)
  • Financials ETF (VFH, A+)
  • Dow Jones US Financial ETF (IYF, A-)
  • Ultra Financials ETF (UYG, A-)
  • Financials AlphaDEX Fund (FXO, A)

Though this comparison is only based on three-year historical returns and the number of holdings in a fund, it is important for investors to take a close look under the hood of the various weighting and selection methodologies, as these differences often have a material impact on bottom line returns.

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Disclosure: No positions at time of writing.