Regulatory Fight Could Leave Financial ETFs Disappointed

Financial services stocks and exchange-traded funds have been in rally mode since President Donald Trump won the 2016 presidential election. Part of the reason for that was Trump's vow to undo some of the post-financial crisis regulatory burden the sector is currently saddled with.

Financials And Dodd-Frank

Enthusiasm for that idea was on display last Friday when the Financial Select Sector SPDR Fund XLF, the largest financial services ETF by assets, jumped 2 percent after Trump signed an executive order to get the ball rolling on undoing the infamous Dodd-Frank legislation. After climbing 22.6 percent last year, good for one of the best performances among the sector SPDR ETFs, XLF is up 2 percent, a middling showing among the sector SPDRs.

Investors appear to be waiting for more regarding XLF, as the ETF has attracted just over $4 million in new assets to start 2017 after hauling in $2.95 billion last year. They could be disappointed on the regulatory front.

“We see Trump’s plans as an opening salvo in an effort to ease the regulatory burden on the nation’s banks. However, efforts to repeal or replace the law in its entirety will be far more difficult, and we don’t expect significant boosts to banks’ profitability in the near future as a result of the rule review alone,” said Morningstar in a note out last Friday.

Looking Farther Down The Line

The research firm also noted that the largest banks, including marquee names found in XLF, may not be on the receiving of the initial end of regulatory easing, if that even comes to pass. That is relevant to XLF because it is a cap-weighted ETF, meaning it allocates large chunks of its weight to the largest U.S. banks and financial services firms.

“We note that most discussion to date has been focused on easing the regulatory burden on smaller banks, not the Wall Street giants. The Financial CHOICE legislation introduced by Republicans contains its own restrictions on “too big to fail” firms and systemic risk and appears to favor 'simplicity.' Thus, the various provisions and rules governing systemically important firms may not be a high priority for change,” added Morningstar.

That could be impactful for an ETF such as the PowerShares S&P SllCp Ficls Ptflio PSCF, which is the small-cap answer to XLF. However, PSCF is up 32.6 percent over the past year, indicating that any disappointments on the regulatory easing front could prompt investors to take profits in this ETF.

Disclosure: Todd Shriber owns shares of XLF.